Aberdeen offices

Economy

Fears of a weak sterling and the prospect of inflation reaching 3% during 2017 have done little to detract from any growing confidence in the Aberdeen market.

Weak sterling played into the hands of the Aberdeen oil market, as production costs are incurred in sterling, against a product sold in US dollars.

The Brent Crude oil market has shown steady growth during 2016 and ended the year as the highest performing major asset class, albeit starting 2016 on a very low base. With the oil and gas sector returning to confidence, we expect to see improved levels of take up during 2017.

The energy sector has become the heartbeat of Aberdeen's economy in recent years. According to figures from Oxford Economics, Mining and Quarrying (including oil and gas) is the most dominant sector and accounted for 21% of the city's economic output in 2016.

Due to the volatility in this sector, Aberdeen has a high proportion of contract workers, who can be hired and fired depending on the price of Brent Crude Oil.

As at end March, Brent Crude Oil is trading at $53 per barrel, a 7% fall on the end of 2016, after the US Department of Energy reported a higher than expected increase in crude inventories.

Oil exploration firm, Hurricane Energy has recently announced it has made the "largest undeveloped discovery" of oil in UK waters, which contains circa one billion barrels of recoverable oil 60km west of Shetland, which will provide a welcome boost to perceptions of untapped resources in the UK Continental Shelf.

Aberdeen is also set to benefit from the completion of the £750 million Aberdeen Western Peripheral Route (AWPR, currently Scotland's largest construction project) during early 2018, which should improve connectivity, ease congestion and boost the wider economy.

Occupational

Aberdeen's office take up excluding renewals and investments reached 183,000 sq ft during 2016, 74% below the long term average of 706,000 sq ft. This was down to the shortage of large deals in the engineering and energy sectors, which have accounted for 74% of take up over the past four years. One of the key deals was PwC acquiring 10,600 sq ft of space at The Capitol, which has undergone a significant redevelopment to provide Grade A office space in the city centre market.

However, 2017 has seen a bounce back in leasing volumes, with 181,000 sq ft of office space taken, driven by Subsea 7's 108,000 sq ft letting at Arnhall Business Park (see Graph 1). Marathon Oil also took 31,668 sq ft of space at the Hill of Rubislaw towards the end of the quarter.

^{Source: Savills Research, Bloomberg}

Despite wider market availability reaching a record level of 2.1m sq ft, there remains a shortage of Grade A office space in the Aberdeen market, which currently stands at 750,000 sq ft (see Graph 2), approximately 2.8 years of supply.

Until large out of town requirements pick up, we expect the 1.3 million sq ft of Grade B/C space to remain stable, much of which lies in secondary locations and business parks.

With the Scottish cities unable to reap the benefits of Permitted Development Rights (PDRs), developers must gain planning permission before converting secondary office space to residential units. With a large proportion of the available office space located on business parks, we do expect to see some put to alternative use.

Top rents remain stable at £32 per sq ft in Aberdeen city centre, although with attractive rent free periods for the best space, net effective rents have reduced.

Top refurbished space is currently quoting £28 per sq ft at 70 Queen's Road, which has closed the differential between new build and refurbished to £4 per sq ft. We expect occupiers will be looking to lease the best quality space at a relatively small premium.

Marischal Square (173,500 sq ft), and The Silver Fin (132,000 sq ft), are the two office schemes currently under construction in the Aberdeen market and are both set to complete during the second half of 2017.

^{Source: Savills Research}

Investment

Aberdeen has historically attracted demand for well-let investments, due to its status as the energy capital of Europe and home to the UK’s oil and gas industry. Furthermore, in recent times, the boom in oil resulted in extremely attractive investment product as a result of the newly created long indexed linked pre-let leases to major operators in the oil industry.

Office investment during 2016 was relatively quiet however, with £30 million of office space transacted, the most notable deal being the purchase at Prime Four Business Park by a private Greek investor.

However, 2017 has started the year more strongly, following LCN Capital Partners' £43 million purchase of Lloyd's Register, which has boosted office investment to £49 million during the first quarter (see Graph 3). Current levels of investor confidence point to a much improved 2017.

^{Source: Property Data}

Investment Market

The first quarter of 2017 also witnessed the high profile merger between engineering firms Wood Group and Amec Foster Wheeler, valuing the company at circa £5 billion. We can expect to see further mergers in the energy sector over the next couple of years as companies look to reduce costs.

Aberdeen saw £50 million of venture capital investment into the city during 2016, marking a record year for the city and a return to business confidence.

Office yields remain attractive in the Aberdeen market and currently stand at 6.75%, above the UK regional average of 5.25% (see Graph 4). One safe haven for Aberdeen is that historically, the exposure to overseas investment is lower than other UK cities which should help to stabilise yields during 2017.

^{Source: Savills Research, Bloomberg}

Outlook

We believe that the worst of the energy market downturn is behind us, and occupier and investor confidence is returning to the market.

One concern for the wider Scotland market that remains is the "spectre" of a second referendum on Scottish independence. Despite Prime Minister Theresa May calling on voters to forget the prospect of a second referendum until voters have seen Brexit in operation, this could knock investor confidence in the short to medium term.

Savills expect take up in the Aberdeen office market to reach 350,000 sq ft, with several requirements over 30,000 sq ft.

Nevertheless, we expect large volumes of secondary space to remain in the market until take up recovers to levels seen during 2013–14. We see this as an asset management opportunity for investors to consider redeveloping secondary stock for alternative uses.

With top rents having settled at £32 per sq ft during 2016, we do not expect further growth over the next 12 months, with incentives remaining competitive.

With Aberdeen yields remaining attractive relative to the rest of UK, the most prime assets will continue to be in high demand as investors look for long term income on a strong covenant.

AN IMPROVED YEAR AHEAD

Simpson Buglass, Head of Aberdeen Office, highlights his key themes

Since the 1970s, Aberdeen and its surrounding areas have enjoyed low levels of unemployment and high levels of disposable income in comparison to other parts of the UK, primarily due to the city’s position as the main European centre for oil and gas exploration and production.

However, in July 2014, the oil price began to fall gradually and, following OPEC’s decision not to reduce supply to support the price as it had done previously, the fall in oil price accelerated, reaching $29 per barrel during January 2016.

This has provided occupiers with an opportunity to acquire good quality office stock at more attractive rents. With secondary stock remaining in the city centre, and increasing demand for city centre living, we can expect to see the conversion of town houses back from office to residential over the next few years.

By comparison, Aberdeen’s industrial market has held up reasonably well with rental values remaining stable over the last 24 months. During 2016, take up reached levels in line with the 10-year average, driven by a 200,000 sq ft pre-let. However, as the oil price remains relatively low, supply has increased. Well located industrial units remain available in The Core, Bridge of Don and ABZ Business Park, with rents generally remaining stable.

Investor appetite is also beginning to show signs of increasing, after a North American investor acquired the Lloyd's Register building in Prime Four Business Park for £41m, which has pushed office investment levels ahead of the volume recorded during 2016. Investors are seeking a "flight to quality," looking for well let assets, which still offer a more attractive yield than the rest of UK.

The city's oil and gas profile has overshadowed the fact that it was already a prosperous city and today still has two universities, a college and three research institutes. Aberdeen services a prosperous hinterland which has significant whisky and agricultural production, and in Peterhead 40 miles north, has the largest white fish port in Europe.