The selloff in non-prime office space over working from home and environmental concerns provides some good investment opportunities, says Schroder Real Estate (SREI ) fund manager Nick Montgomery.

Montgomery, head of UK real estate at Schroders Capital, points to the wide yield gap between secondary and prime commercial properties to show that the slump in some office valuations has gone too far. Some of these properties can be refurbished and revived, he says.

This is the third excerpt from our virtual event with Schroder Real Estate last week. You can watch the previous excerpts:

• Schroders: Why UK real estate looks compelling;
• Schroders: 2023 was third-best year for rental growth in two decades.

Or you can watch the entire one-hour ‘Big Broadcast’ of the whole programme. 

Can’t watch now? Read the transcript

Nick Montgomery:

Now, the office sector, it’s worth just touching on this. So we are underweight offices, but we think actually, there’s an interesting opportunity coming in the office sector. So the chart on the left is showing a couple of things. The first thing it’s showing is the light blue line represents the average yield on secondary offices, so grade-B offices, for want of a better expression, and the dark blue there, you’ve got prime offices, the best quality, you let them on the longest lease etcetera.

And you can see the gap between those two from 2009 to today has got progressively wider over the course of the last 12 months in particular. In fact, if you look at the spread, the spread between prime and secondary, which was represented by the grey bar with reference to the right-hand side, it’s never been higher. So that’s all about investors’ concern about secondary offices, impact of working from home, impact of high refurbishing costs, in particular to address sustainability requirements from occupiers.

Now, our view is that does potentially present an opportunity. We’ve got a very good specialist team within the real estate business. We’ve got specialists across all sectors, including offices, including a team based in Manchester. And the other point to note in relation to this is there is very limited supply coming forward, but the data on the right-hand side is showing you - in the dark blue line there - net additions as a percentage of total stock.

And essentially, the total stock of offices in the ‘Big Six’ regional cities is actually falling in absolute terms. And that’s because space is being taken out of supply, in many cases residential, but it could be student, and if you look forward, there isn’t a huge amount of capital going to development, there’s very limited supply coming through, so if you’ve got the ability to reposition space, particularly given councils’ increasing focus on retaining existing building stock because of the embodied carbon, we think that’s a really quite interesting place.