A swathe of office buildings across the South East of England has been earmarked for conversion to residential, driven by recent government relaxation of legislation around permitted development and improving values for residential compared with offices.
Lambert Smith Hampton says the trend reflects the "flight to quality" by occupiers, who favour new buildings with more amenities and better ESG credentials, which is leaving older office stock effectively redundant. It says this has an impact on capital values as investors wake up to the opportunity to realise more gains through redevelopment.
The recent relaxation of Permitted Development Rights has created huge opportunities for office-to-residential conversions, too. In February the government laid legislation in Parliament to extend current PDR so that commercial buildings of any size can be converted into new homes.
The government said the move, will cut red tape that stops derelict sites and unused buildings being turned into new homes. It added this means shops, offices, and other buildings can be quickly repurposed, resulting in "thousands of quality new homes by 2030".
Permitted Development Rights are granted by central government which means a developer can go ahead without securing further planning permission. Previously used primarily for small works such as household extensions, the government introduced a series of more significant rights to create new homes without planning permission from 2013, with an increased focus on offices and shops. In 2021 the size of the commercial building was limited to 16,145 square feet of floorspace.
The recent amendments are the latest in a series of changes that have been made to office-to-residential PD since the original Class O rights were introduced in 2013. These unleashed a wave of conversions that, at its peak, saw 17,751 new homes delivered in 2016-17 in England via changes of use from offices. Over 60% of all PD conversions have come in either Greater London, the South East or the East of England, but the total number delivered each year has dwindled by more than half since the peak, LSH reports.
But LSH warns political uncertainty hangs over the future of PD. "The current window of opportunity may not be open for very long and, for many landlords considering residential conversions for underperforming office assets, the time to act is now."
LSH conducted an audit of office buildings across the South East and has identified 12.9 million square feet of space (equivalent to 20,000 two-bed flats) targeted for conversion to residential use. This audit includes buildings built before 2012 with high levels of vacancy or imminent breaks or expiries.
Markets with the largest opportunities are Reading (1.9 million square feet), Blackwater Valley (1 million square feet), and the south coast (1 million square feet). Meanwhile, PD opportunities form the largest proportions of the existing stock in Marlow, Uxbridge and Reading. PD targets represent close to 20% of the total stock of these markets, compared with a region-wide average of 7.5%.
Office-to-residential conversions can also still be blocked by Article 4 Directions, which allow Local Planning Authorities to remove PD rights in specific areas. As LSH says there has been speculation that Local Authorities wary of losing employment space will seek to increase the use of Article 4s in reaction to the recent loosening of PD rights. Equally, it can take a Local Authority a significant amount of time to bring in an Article 4 Direction, so a window of opportunity appears to be open in locations where Article 4s are not currently in place.
LSH points out that any Local Authority attempting to extend Article 4 provisions could also find itself in conflict with the Secretary of State for Levelling Up, Housing and Communities, which has sought to limit their use in line with the National Planning Policy Framework’s stipulation that they are “based on robust evidence and apply to the smallest geographical area possible”. Within the last year, the Secretary of State has modified Article 4 Directions in locations including Watford, Reading, Rushmoor, Three Rivers, Hertsmere and Hillingdon. LSH says: "Developers should be attentive to any opportunities created by the redrawing of Article 4 maps."
LSH reports investment in offices-for-residential conversion has been dominating in the region and says the South East is showing signs of stabilising after a severe correction.
Following very subdued volume of £264 million in the first quarter, volume in the second quarter is expected to rebound to circa £450 million, of which some £250 million of stock is earmarked for conversion to residential uses.
This year the largest such acquisition has been residential developer Hadley's acquisition of GSK House, the former headquarters of GlaxoSmithKline in Brentford, for around £69 million.
Jonathan Scott, director at LSH, said: “Movements in capital values have heightened the case for office-to-residential conversions. According to our calculations, residential values per square feet are now on average 53% higher than office values across the wider South East and East of England area. This gap has widened significantly following the sharp repricing of office values seen since late 2022, and particularly large margins to secondary office values have emerged in many locations. While the first wave of office-to-residential conversions was triggered by legislative change, an imminent second wave could be equally driven by shifts in values.”
With occupier demand increasingly focused on prime office space suited to post-COVID requirements, many South East markets will likely see poorer quality space either repositioned as higher quality offices, or completely removed from the market via changes of use. LSH says PD rights are an important tool that, used correctly, will support the creation of right-sized office markets more concentrated on grade A space.
It says the recent removal of size and vacancy restrictions has opened up the option of office-to-residential PD conversion to a much wider range of buildings.