Richard Yorke, Director of Analytics, CoStar Group
London and New York are arguably the world’s two great global cities. Different but remarkably similar, the two have been locked in transatlantic competition for decades. Each has enjoyed a period of preeminence, often reflecting the relative power of the financial and business clusters that have evolved in both.
But what about the other big cities in the UK and U.S.? Each city is of course unique, but will globalisation and urbanisation increasingly pitch these cities against each other in a kind of NFL (National Football League) and EPL (English Premier League) playoff? CoStar data and analysis suggests that this is an increasing probability.
CoStar tracks activity at a corporate, tenant, and building level in all U.S. and UK cities. Our data for the six largest office markets in the U.S. and UK, excluding New York and London, reveals that office take-up is largely driven by professional services; technology, media, and telecoms (TMT); and banking and finance. This is especially true of the UK whereas the U.S. is rather more broadly based, with the public sector, retail, manufacturing, and energy sectors making a bigger contribution.
These key corporate sectors are increasingly footloose, which means U.S. and UK cities, and many others globally, are in a race to attract and retain these companies. Some will succeed and others struggle. Typically these businesses tend to cluster where there is good access to the right kind of talent, customer markets, finance, infrastructure, and property, amongst other draws. This is especially true of the TMT sector, which has tended to cluster in CBDs and certain out-of-town locations.
San Francisco, unsurprisingly, is by far the largest destination for TMT, which took up nearly 6.8 million SF of office space in 2014–15, equivalent to 26% of office take-up. However, what is perhaps surprising is that Bristol (22%), Edinburgh (20%), and Glasgow (12%) are in the top six cities in terms of the relative importance of TMT. These are increasingly internationally important TMT centres attracting firms from across the globe, including U.S. companies such as IMDB and Hewlett Packard in Bristol. Similarly, FanDuel, the U.S.-focused fantasy sports provider took 60,000 SF of office space in Edinburgh in 2015. Cirrus Logic, a U.S. software firm, took a similar amount. Dell expanded its Glasgow operation, too.
These new occupiers are increasingly driven by the need to attract and retain talent. This is influencing the type and quality of buildings and spaces they occupy. Buildings need to be sexy, not just efficient. This trend is supported by CoStar data, which reveals that the majority of space leased by banking and finance and business and professional services in the big six U.S. cities is prime, equivalent to the CoStar 4 & 5 Star rating.
Interestingly, space leased in the U.S. has been relatively better quality than that occupied in the UK in recent years. Moreover, the majority of leased TMT space in the UK cities has been non-prime – 1 to 3 Star – rather than the 4 & 5 Star buildings favoured in the U.S. This reflects little development in the UK since 2008 and the consequential lack of new space.
The relative lack of available prime space in UK cities has forced companies, especially in the TMT sector, to occupy older stock. Developers have responded by upgrading older buildings in CBD and city fringe locations. We have noted a significant increase in investment targeting UK buildings with refurbishment potential. These refurbishments and redevelopments have often formed part of wider economic and urban regeneration schemes designed to create the kind of places where people want to live and work. This is an important attractor to new businesses looking to relocate.
The lack of prime space in UK cities has kept average rents for the TMT sector below those achieved in most of the U.S. cities in our list. San Francisco is the most expensive market by far ($49.7/SF) and Los Angeles ($12.6/SF) the cheapest. Although Bristol is the most expensive UK city, the spread between it and the cheapest – Leeds – is narrow. Consequently, these cities cannot rely on price alone to compete against each other. Hence, the need to offer other attractions, such as the availability of skilled workers and good quality of life.
The expansion of the TMT sector has meant that average rents have increased markedly in a number of markets. San Francisco rents have shot up 25% on average. Rent increases have been much more subdued amongst the UK cities, reflecting the preponderance of 1 to 3 Star buildings. This has boosted the attractiveness of these cities, especially for start-ups and SMEs that want low rents now but have high growth potential. This is how clusters often emerge.
The lack of new buildings in these UK cities means that TMT deals have on average been much smaller than in the U.S. However, this has not been the case for banking and finance occupiers, which typically took the biggest spaces in Edinburgh and Glasgow in 2014–15. Notable deals in these cities included those by Blackrock, JP Morgan, Morgan Stanley, and AIG, all big U.S. financial players.
Developers and investors are responding to occupier demand with a wave of new of buildings and refurbishments. CoStar data shows that Seattle, San Francisco, Manchester, Washington, D.C., and Birmingham are due for the largest proportionate increase in office stock over the next few years. Washington, D.C., is set to see the largest absolute increase (8.5 million SF), followed by Seattle (6.9 million SF) and Boston (6.3 million). The UK city development pipeline is much smaller and is led by Manchester (1.4 million SF), although it is set to experience the third-highest proportionate increase of the cities assessed. This development will increase the quantity and quality of office stock and underpin attractiveness.
In terms of inter-regional competition between U.S. and UK cities, British government policy is arguably making an even bigger impact by encouraging a wave of U.S. to UK relocations. This has been underpinned by tax changes, especially reductions in the corporate tax rate to 20% compared to a U.S. rate of 35%. U.S. companies have also been keen to use overseas cash to fund such moves rather than repatriating it back home, where it would be taxed. Examples of companies that have moved their tax base to the UK include Aon Plc, CNH Global N.V., Delphi Automotive Plc, Ensco Plc, Liberty Global Plc, and Noble Corp. Plc.
Although London has been the traditional landing pad for such relocations, corporates such as HSBC and Deutsche have recently relocated large parts of their operations out of expensive London to cheaper Manchester and Birmingham, which increasingly boast comparable properties and people. U.S. businesses have become an increasing presence in these cities. For example, such U.S. firms as Muznich and Co (asset management), Latham and Watkins (law firm), and Ford Credit (financer) have taken substantial office space in Manchester in the last year or so.
What does this mean for the future? Going forward international companies including U.S. firms looking to relocate to the UK might well ignore London and head straight to other UK cities. A plethora of inward investment agencies have been established solely to promote these cities and are using detailed data about the availability and cost of property and skills to paint a favourable picture. This strategy is working with EY reporting that 40 multinational firms, many U.S. based, are looking to move global or regional headquarters to the UK.
That said, the future is not certain. Unfolding events this year, including the referendum on whether the UK should leave the European Union – the Brexit – and U.S. presidential elections, may slow or even reverse the trend for U.S. businesses to relocate to the UK. Inevitably the ebb and flow of competition, the playoff between cities seeking the same kinds of global footloose occupiers and investment, will continue apace.
The above is an excerpt from the Spring 2016 edition of the Occupier Edge. To gain other valuable commercial real estate insights, download the Spring 2016 edition of the Occupier Edge here.