Cities of the future

As more office jobs are set to be automated, forward-thinking investors need to think carefully about the sustainability of the cities where they choose to hold exposure.

3 minute read

Salford Quays at night

With the shift to a service-based economy, the role of cities as hubs of interconnected knowledge networks has become increasingly important. The most successful cities are those that have been able to act as a crucible of ideas, generating agglomeration effects through the sharing of information. Much information can be codified in forms such as books and manuals and shared across great distances. But in many cases, knowledge is most easily shared face-to-face. Cities can facilitate the sharing of this tacit knowledge.

However, not all cities are equally well equipped to drive growth of the knowledge-based economy. The geography of knowledge is not evenly spread. Historical concentrations of tacit knowledge and established knowledge networks give certain cities clear advantages. Size, density and good connectivity helps too.

It is more important than ever for real estate investors to be aware of these trends. The rise of knowledge-based industries is set to remain a key driver of growth and will combine with technological change to reshape demand for office space. According to Deloitte, 35% of UK jobs are at high risk from automation over the next two decades. A high proportion of these will be office-based jobs. But these will mostly be more routine, lower value-adding roles. The office demand from more knowledge intensive, higher value-adding activities is likely to prove more robust.

Office markets that compete primarily on cost are structurally challenged. The types of economic activity accommodated by offices in such locations are particularly at risk from automation. Office occupation for back office operations or government administration is likely to diminish over time. These trends will impact on some markets, including some smaller UK cities, particularly hard.

Long term office investors would therefore be well advised to discriminate heavily in favour of locations where there are established clusters of high value-add economic activities and deep pools of highly skilled labour. It seems appropriate to favour locations where there is a concentration of knowledge-intensive private sector jobs. Generally, cities where highly-skilled workers want to live, work, play and learn are likely to have more robust demand.

In an era of continued globalisation, cities that are able to attract and retain highly skilled talent will be further advantaged if they have an international profile and are globally connected. In the UK, Manchester, Birmingham and Cambridge meet these criteria and, to varying degrees, also currently benefit from forward-thinking policy makers and significant infrastructure investment.

Manchester has the deepest pool of highly skilled labour outside of London and is home to top-rated universities boasting impressive graduate retention rates. It is an internationally recognised city that successfully competes for inward investment at a European level. Manchester Airport connects the city to US, European and Chinese global cities while the local economy is benefitting from the improved connectivity offered by the recent extension to the Metrolink. Unlike many other cities, policy-making has acted as a major enabler of economic development in recent years. In part reflecting the successful track record the boroughs of Greater Manchester have in working together, the city region is set to receive an extensive devolution deal. This bodes well for the city’s future prospects.

Birmingham has added many jobs in knowledge-based industries in recent years helped by a thriving city centre, the presence of the International Convention Centre and strengthening professional services sector, notably insurance and legal services. Furthermore, if the high-speed rail network HS2 is built the journey time to London may drop to 49 minutes compared with about 90 minutes currently.

Cambridge is a globally recognised pharmaceutical and biotech hub. Over the past 40 years a thriving technology cluster has evolved made up of 4,300 knowledge intensive businesses, The University of Cambridge and a number of specialised research institutions. These businesses alone employ 58,000 and have a combined turnover of £11bn. More than 30 of the world’s largest and most important corporations have established operations in Cambridge to tap into this innovative ecosystem.

These credentials mean we have more confidence in the long-term robustness of demand for office space in these markets than we have in the majority of others. Clearly, though, investors need to give consideration to both demand and supply factors. On the supply side, cities with structurally high levels of supply are to be avoided. Instead, investors should favour cities with high barriers to entry. Markets where there are limits to the pace and the extent of future development are more likely to generate rental growth in the long run. So cities with a dense, well established core should achieve stronger rental growth than markets where an out-of-town market competes directly with the city centre.

Focusing on cities where highly skilled people want to live, work, play and learn and where supply-side risks are constrained should ensure investors have exposure to the most robust office markets. Strong out-performance will not come from simply being in the right cities. Real estate is a local asset class in which access to information is a competitive advantage. Investors with the greatest city-level expertise and that are the most deeply embedded in markets are therefore the best positioned to create value through asset management and by sourcing the most attractive buying and selling opportunities. So by focusing on the most robust office markets and developing deep expertise, real estate investors position themselves to make the large conviction calls that are required for sustained investment out-performance.

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