DTZ Holdings plc : DTZ Research: Poor quality secondary office floorspace accounts for 70% of total UK stock UK | 14 December, 2011

• Nearly 70% of total UK office stock is estimated to be poor quality secondary, categorised as grade C
• Contrary to popular belief, availability of grade C office space is only 3.5%, much lower than for grades A and B, at 12% and 19% respectively
• Despite this, we expect grade C availability to increase in regional locations in future, as tenants move to class B and A space following lease events
• As this happens, we expect there to be little appetite for redevelopment in regional markets, creating a problem in terms of recycling unwanted stock.

Poor quality secondary office floorspace accounts for almost 70% (721m sq ft) of total UK office stock, according to new research by DTZ . This report considers quality of office space, defined in terms of grade A (prime), B (good quality secondary) and C (poor quality secondary). It reveals significant variations in the proportion of grade C space across the UK office market.

The highest proportion of grade C stock is in the minor UK markets (85%) where low development activity has resulted in only a small amount of modern stock. London outside the City & Fringes also has a high proportion (68%) due to low development activity in most locations except the West End and west London. In central London, where the value of land has justified a more intense level of development and superior build quality, grade C space accounts for more than half of all stock (54%). Grade C space in most markets exceeds the total amount of grade A and B space.

Grades A and B account for around 9% and 22% of UK stock respectively. Outside the main office markets the figures drop to less than 4% for grade A and 11% for grade B.

Hans Vrensen, Global Head of Research at DTZ said: "This analysis is an initial step towards sizing the non-prime market. This is important given that non-prime property is collateral for much of the circa £300bn real estate debt in the UK. The work-out of loans against non-prime property still has a long way to go, as we saw in the lenders survey we conducted as part of this year's Money into Property research . Over half the lenders surveyed believed that the work-out for non-prime assets had yet to start."

Martin Davis, Head of UK Research at DTZ added: "Our analysis suggests that over two-thirds of the UK's office stock can be classified as poor quality secondary. This is based on a bottom up assessment of nearly 3,000 buildings covering 164m sq ft in Birmingham, London City & fringes and Reading as representative markets for the UK as a whole. This analysis was further extended to the rest of the UK by using a variety of sources and by assuming a certain relationship between quality and age of office buildings in these other markets."

The research highlights that, contrary to popular belief, availability of grade C office space is lower than grades A and B. Despite doubling in regional markets since 2008, the proportion of grade C space that is available across major UK markets is estimated to be only 3.5%, compared to 12% for grade B and 19% for grade A.

However, DTZ expects that grade C availability will increase further in regional locations in the coming years. Grade A and B landlords are offering significant incentives to encourage grade C tenants to move on low cost or cost-neutral upgrades. This trend has already been observed in the big nine regional UK markets, as tenants have upgraded from grade B to A.

"Contrary to our expectations grade C has a lower availability rate than grade A and B stock. Nevertheless, we expect this position to deteriorate in the face of continued low economic growth and competition for occupiers from better quality space", Martin Davis added.

One solution to address obsolete grade C space is redevelopment. However, DTZ's research shows that this is more likely in London City than in regional markets. In the City, 14% of grade C stock is subject to some kind of development interest, with few non-office sites available for redevelopment. In regional markets, developers have more options for redeveloping non-office sites, and consequently not much grade C office floorspace is likely to be recycled.

Alternative use is a possibility, particularly in London. Over the last decade 5.4m sq ft of office space has been redeveloped in London with change of use to residential (3.5m sq ft), hotels (1.5m sq ft) and student accommodation (0.4m sq ft).

Martin Davis added: "Beyond London the prospects for alternative uses are less easy to implement, certainly for residential development while the market is weak. This creates a problem for grade C owners in terms of recycling unwanted stock - especially since grade C availability is likely to be higher in less developed markets outside of London."