Potential upside for office rental value growth - Capital Economics
UK Commercial Property

Potential upside for office rental value growth

UK Commercial Property Update
Written by Gabriella Dickens

Given that employment growth has probably peaked, we expect office occupier demand to slow further over the next year or so, which will act as a drag on rental value growth. But the labour market may not be as tight as it first appears, so the risks to our forecast for both office occupier demand and rental values lie to the upside.

  • Given that employment growth has probably peaked, we expect office occupier demand to slow further over the next year or so, which will act as a drag on rental value growth. But the labour market may not be as tight as it first appears, so the risks to our forecast for both office occupier demand and rental values lie to the upside.
  • Our forecast for office rental value growth hinges on our view that the labour market is near full capacity. Indeed, at 3.8%, the unemployment rate is at its lowest since records began. And there are signs that cracks are beginning to appear. Employment fell by 58,000 in the three months to September, in sharp contrast to the 114,000 rise in the three months to June. And annual employment growth had slowed from 1.5% y/y at the start of the year to around 1% in September. But what does this mean for rental value growth?
  • With employment growth slowing, we think occupier demand will most likely slow further, which will weigh on rental value growth. Although we don’t expect office rental values to fall outright, we expect growth to edge down from 1.3% y/y this year to 0.9% by the end of 2020. (See Chart 1.)
  • And we expect that employment growth will slow whether a deal is implemented on the 31st January or if Brexit is delayed again. If a deal goes ahead, we think that employment growth will slow from 1.1% y/y this year to 0.4% y/y by the end of 2020. And if Brexit is delayed again, the continued reluctance of businesses to invest in capital would mean stronger demand for labour, which would partly offset weaker economic growth. In both cases, rental growth will slow.
  • That said, in recent years, employment growth has tended surprise to the upside. And while the labour market appears tight by past standards, the unemployment rate is still slightly above our estimate of the natural rate of unemployment (NRU). That’s the rate at which the labour market is at full capacity and is neither exerting upward or downward pressure on wage inflation.
  • Indeed, in a recent Focus, we estimated that the NRU had fallen to around 3.75%, well below the Bank of England’s estimate of 4.25%. (See Chart 2.) That means the unemployment rate could feasibly fall a little further without causing a sharp increase in wage inflation, leaving room for employment growth to hold up better than we expect.
  • The big picture is that rental growth looks set to slow over the next year or so, as occupier demand softens. But potentially stronger-than-expected employment growth means occupier demand could do a little better than we expect. As a result, the risk to our office rental growth forecast lie to the upside.

Chart 1: UK Office Employment Growth and All Office Rents (% y/y)

Chart 2: UK Natural Rate of Unemployment Estimates & Unemployment Rate (%)

Sources: ONS, MSCI, Capital Economics

Sources: OECD, BoE, ONS, Capital Economics


Gabriella Dickens, Assistant Economist, 020 3974 7421, gabriella.dickens@capitaleconomics.com