When Two Become One By Dr Lee Elliott

Conventional wisdom suggests that corporate merger and acquisition (M&A) activity has a negative impact on demand in U.K. office markets. However the reverse may well be true. 

An uncertain political and economic backdrop seems to have done little to suppress demand for office accommodation in the U.K. with the main office markets achieving new benchmarks during 2018. 

In the Central London market, for example, almost 15 million sq.ft of space was let to businesses last year, a figure some 20% above the long-term average, and the highest annual volume since 2014. It was a similar story outside of the capital. The M25 market witnessed a decade high of four million sq.ft of office space let, while the ten main cities of the U.K. also exceeded their long-term average by a fifth, with six million sq.ft of space let to a broad spectrum of business users.

New Drivers Of Office Demand 

It is clear that despite operational uncertainty, the office occupier is active. In my view, they will continue to be so, for two reasons.  

First, real estate has a new standing as a business tool. It is no longer simply a business cost to manage downwards; no longer just a necessary factor of production; no longer merely a container in which to put people. Instead, it is a strategic device used pro-actively by business leaders to support, facilitate or portray strategic business transformation. Indeed, this was a key finding of Knight Frank’s recent (Y)OUR SPACE report. Eighty-six percent of the global corporate real estate leaders of 120 of the world’s biggest firms view real estate as a strategic device that assists wider business goals relating to strategic issues such as talent management, corporate branding, employee wellness, business innovation or, importantly, changes in business structure. 

It is these changes in the structure, culture and constituents of business that represent the second driver of office market demand. Every business sector is being dramatically disrupted by the onset of digital technology. As a result, all businesses are being reshaped by the need to develop a different go-to-market strategy and customer experience that is more appropriate to the digital age. This, in turn, is forcing a rapid and regular reconsideration of the quantum and qualities of required staff; the underlying business culture (with innovation, rather than scale, being the key to business competitiveness) and the organisational structure of the business. 

This last point of structural change is important. Businesses are changing shape with an ever-greater frequency and significance. For example, we have seen the emergence of corporate fissure, whereby established companies such as Hewlett Packard have responded to the new digital reality by breaking down into new separate entities. However, by far the most obvious manifestation of this structural change has been the dramatic increase in corporate M&A activity.  

Recently released data by the Office for National Statistics (ONS) found that acquisitions of UK companies by other UK companies hit a ten-year high last year, with some £26.5bn of deals completed. Furthermore, takeovers of UK companies by foreign firms doubled year on year in 2018 to stand at some £71.1bn. This is set against a global backdrop, which according to leading data and intelligence provider Mergermarket, saw some US$3.5 trillion of corporate M&A activity in 2018, spread across more than 19,000 transactions. As businesses are disrupted and challenged, M&A activity is becoming a strategic response by those with the financial clout to dominate or those who need to bring radical change to their organisation in order to remain relevant. 

The Real Estate Market Significance Of M&A Activity 

M&A activity has however been somewhat of a blind spot for those forecasting the future demand profile of the UK office market. Whilst recognising that such activity can serve to reduce the presence of occupiers in some markets, I believe M&A to be an important stimulus of future demand.  

The key reason for this is that the character of M&A activity is changing quite markedly.   There are, as outlined, lots of deals being completed but the individual deals are themselves becoming more significant with a growing proportion of deals falling into the category of mega-deals – that is with a total value in excess of $10bn. 

Still more significant is that a growing proportion of the deals are what economists refer to as horizontal rather than vertical integrations. Put simply, a larger proportion of deals are occurring across rather than within industry sectors. The big deals in the market are increasingly seeing companies buying companies in completely different sectors which are ripe for technological transformation or which provide access to new capabilities and skills.  

This activity extends the power of disruption. When a company with the clout and technological know-how of, for example, Amazon enters into a completely different sector its impact transcends the confines of the merger itself. So, if Amazon were to go into the healthcare sector they would create a powerful new market entrant that would send strong shock-waves through the entire sector. Traditional sector incumbents would have little choice but to react and respond. They do so by changing their own business structures, their operational model and, in some instances, by themselves combining forces with other entities. In this sense, horizontal M&A activity creates a much broader demand stimulus for office markets than simply the individual deals themselves. 

There is a further interesting dynamic occurring. Historically, a corporate merger makes financial provision for the running of duplicated real estate portfolios for around 2-3 years.  Thereafter, the new merged entity has typically reviewed its extended occupational portfolio, made choices about which properties to retain and which to exit, and then transacted in the market accordingly. However, this process is changing. 

In an age where real estate is a device to facilitate, support or portray business transformation it is more likely that the new entity formed by the merger will remove itself from much of its legacy portfolio and take on completely new offices that serve to embolden the brand of the new business.  

In this sense, the coming together of separate businesses through an M&A deal will stimulate further high levels of occupier demand within the UK office markets over the next five years.  Such deals further embody the notion that, from a real estate perspective, business disruption equals ongoing market demand.