Oiling the cogs of growth: Gove’s office conversion plans

At the end of February Kristian Niemietz cast an eye over Michael Gove’s announcement of a revised policy intending to relax some restrictions on the conversion of offices into residential property. He also drew attention to a blog I had written making similar proposals a few months prior and speculating on the blog’s catalytic effect. It would be nice to think that there was such a link, ‘and yet’ Kristian continued, alluding to moving deck chairs on the Titanic, the change of rules merely moves supply from one constrained class of property assets to another, without relaxing overall supply constraints.

To support his argument, he showed figures for rents for prime London office space (rents which far exceeds those of Continental cities) suggesting that London is not a city with a huge surplus of office blocks, and it is the return at the office-residential margin that dictates conversion. This is a fair and important point, but I will now argue the issue is more complex, and, yes, conversion can still make an important contribution to economic welfare, even within the constraint of constraints.

First, some observations on Kristian’s supporting evidence on rents. The London figure is for prime office space in arguably the world’s second most important financial centre; it does not (pretend to) represent non-prime office rents nor those in provincial cities such as Reading, Leeds or Bristol mentioned in my original piece. And there is good reason to expect a huge difference as I will explain shortly. It is also a figure for 2022, since when vacancy rates have soared, although less so in the City and possibly the West End; Canary Wharf is a different matter. Even so, since 2022 big office landlords have been cutting their portfolio valuations, British Land by 25% and Landsec by 15%, suggesting rents are falling. Rents on new leases are most likely a lagging indicator of the propensity to WFH, a trend boosted by Covid policies.

Now for the nub of the argument which concerns rental gradients, in turn a reflection of land value gradients, a central tenet in urban economics. Briefly, theory suggests that for many types of activity and thus land use, centrality is important, sometimes essential. And because space naturally is in shorter supply towards the centre of cities, it is more expensive; rents (sale prices) are higher. Shortage can be alleviated of course by generally building to, and occupying at, higher densities (a decline in quality) or building skywards. But this latter substitution of capital for land is an expensive undertaking (imagine the current logistical nightmare of trying to provide construction materials in the City of London with its collar of congested, pedestrian and cycle-ridden, rule invested maize of streets). Whether the cost of building centrally is incurred, is driven by a willingness on the part of the end consumer to pay, whether a flat-loving relatively wealthy resident, or a corporate business.

Thus, all cities have rent gradients, whether for residential property, retail or for offices. There are a few western cities in which these gradients are shallow, Perth, Western Australia is one with which I am familiar, and it is shallow because of very low densities of living encouraged by a good  street/road network and, formerly at least, modest controls on peripheral land use; but office rents remain higher in the  city centre than at the periphery. Indeed, for a central place with no planning controls at all, but a growing population (or a static population with growing real incomes) will in all likelihood see an increase in rent gradients.

Prime office rentals are a stand out in this scenario and especially those in London, a world city where the tertiary sector of the economy is pre-eminent. Office functions traditionally have placed a greater value on central places than all other land uses, largely because of agglomeration economies that come from clustering such knowledge-based activities. As the economist John Dunning said when writing about the City of London many years ago, ’…top of the hierarchy [is] …an elite group of co-ordinators, decision-takers and policy-makers, with their supporting staff; those who need to be in close proximity to others so as to negotiate, to converse, to gain or pass on information and ideas.’ For this reason, office rents in prime locations eclipsed all other land uses. It is a stand-out that would prevail in a well-functioning urban land market with no planning constraints.

What has happened recently is a slight weakening of those agglomeration economies as modern internet-based communication has reduced the need for face-to-face contact, particularly contact with supporting staff. Add a rather lacklustre economy, political uncertainty and tighter regulation in financial services and, unsurprisingly, demand is less strong, rents are falling and the rental gradient reflecting the centrality of office demand graduating a little. At the intersecting margin of the rental gradients, for residential and office space, it becomes financially viable to convert more offices to residential use. Relaxation of controls on such conversions helps to oil the wheel of a functioning market.


David Starkie’s latest book, Airport Enterprises: An Economic Analysis is published by the Regulatory Policy Institute, Oxford, and is also available through Amazon.

1 thought on “Oiling the cogs of growth: Gove’s office conversion plans”

  1. Posted 05/04/2024 at 17:48 | Permalink

    In terms of residential conversions from inner city offices does green environmental living ever enter into the market equation?

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