Our London Office Market Snapshot. 2020 Q4
As we move through a period of seismic change in the property market, SHB are launching our version of a quarterly report. We have emerged as a company both in touch representing a large portion of the commercial occupier’s market, we have reached a place where we want to offer our analysis of the commercial landscape to a wide audience. Providing clear and honest views, this is designed to give a true and pure angle on what is going on now, and what professionally SHB believes will be coming our way. We want to share the benefit of our findings and views to all occupiers who would like to read and soak it up.
What You Will Find in this Snapshot Report:
· Central London Overview
· Market Rents
· Take Up
· Leasing Activity
· Vacancy Rates and Availability
· Sales Market
· Construction Pipeline
· Industry Analysis
· Our Summary
Central London Overview:
Since the emergence of the coronavirus, the London markets have been at a virtual standstill, with relocation activity falling to record low levels. At the same time occupiers from all sectors have been trying to understand what COVID-19 might mean when considering the future of the office. The immediate impact of this has seen occupiers with imminent lease events trying to negotiate short term extensions with many occupiers choosing to move over from conventional leases to serviced/managed arrangements, and in a growing number of cases occupiers pulled out of the leasing market all together, choosing to wait until the landscape becomes a bit clearer.
These are strange times indeed and Landlords across London will need to adapt their approaches and become far more thoughtful about what occupiers might want/need, and what will get those occupiers to divert their attentions to their buildings with a view to embracing the relocation process. This can clearly be seen in the explosion of Cat A + offerings and the rise in the quality and finishes in these products and it feels like we are very much at the early stages of this part of the property revolution. Perhaps in the future rather than Cat A + dominating the sub 4k sq. ft. markets, we will start to see a more normal movement towards much larger floor plates and/or buildings where the Landlord becomes responsible for the Tenants CAT B works. We will see, but for now, it is very important the Landlords and their agents are honest about what might be coming. Let’s have a closer look…
The mainstream media anticipated that there was going to be an immediate and drastic reduction in rents due to the uncertainty around the pandemic and those impacts on an already volatile economy. In reality, the Central London submarkets rental values have only fallen on average by 1.97% in Q4 2020 compared to Q4 2019. Occupier advisors throughout the market would argue that providers of space are being too slow to respond to variables such as unemployment, the social-impacts post pandemic (commuting, travel and City living) and the reduction in working capital for organisations (cross-sector). When considering such variables and comparing this CRE downturn to previous others such as the 2008 crash, marketed rents and achieved rents could drop by an average of 10–15% across the Central London Markets.
This idea is reinforced by record amounts of space on the market despite some murmurs that demand for space is increasing. This ultimately allows tenants to shop around for their needs and thus, creating high levels of competition for providers of space — inevitably putting pressure on the current marketed rental values. Market data suggests that rents in the core West End and City Markets have only slipped by an average of 1.35% and 2.45% respectively in the final quarter of 2020 compared to that of 2019, however, the evidence coming out of the latest SHB Real Estate deals done suggest between 7% and 9% reduction on new leases and medium to long term regears. The latest of these being a lease regear in prime Mayfair for a CRE fund and a new 5-year lease in the City for an Engineering firm.
All this data highlights that there is a positive correlation between the submarkets with highest vacancy rates such as the City Core (2.45% reduction), Southbank (2.62% reduction) and Midtown (4.1% reduction) and the greater % change (reduction) in rents from Q4 19’ to Q4 20’ — solidifying that rents will have no choice other than to adapt downwards as vacancy rates continue to rise and pressure builds on the buildings with voids.
The majority of landlords are being extremely pragmatic on the negotiation table and trying to beat any rental reset by incentivising tenants with inflated rent-free (RF) packages and capital contributions, mainly due to this being less detrimental to the value of their asset and likely impacts on their funding structures. On average, RF packages have increased from 1.5–2 months per year guaranteed of the lease (5-year term certain) to 2.5–3 months in the Core Markets and transactions we have agreed in the fringe markets such as Stratford and Docklands have exceeded 3 months per year guaranteed of the lease — allowing the overall net outgoings per annum and psf to be squeezed.
Take Up/Leasing Activity
Take up across London has fallen due to the Pandemic starting in March 2020 which is not surprising at all. Across London, since Q4 2019 (where take up was hugely positive, nearly 3.3m sqft) the trend has been that more space has hit the market than has been taken. In total, just 5.13m sqft has been taken up over the whole of 2020, less than the combined take up in the 2nd half of 2019. Q4 2020 comprised just under 900,000 sqft of that 5m sqft, a 75% drop compared with Q4 2019.
The submarket with the largest take up in Q4 2020 was the City North area which included deals to City University at 33 Finsbury Square.
The final few months of 2019 experienced boosts in consumer confidence and demand via the news of a majority Conservative government setting a firm date for the UK to leave the EU, thus providing business with assurance of what is going to happen and when. During this period, we saw some big-name brands such as Apple, The Office Group, Facebook, Monzo and L’Oreal all taking between 156,442 sqft to 120,217 sqft (in descending order) representing strong leasing activity. To compare with this, in Q4 2020 there were fewer big names willing to transact with some key deals to note being City University, CPPIB, The New College of Humanities and Hines all transacting between 74,379 sqft to 35,700 sqft (in descending order). This contrast in the leasing activity is a reflection on how the pandemic has impacted companies’ confidence and willingness to transact during this uncertain period throughout the market.
SHB deals for this quarter included a further floor of 32,500 sqft in Republic for LCA (part of Anglia Ruskin University) as well as some smaller serviced office deals which showed occupier’s tentativeness to commit to longer terms in this current climate.
Vacancy Rates & Availability
Vacancy has and will continue to be shaped by external forces, pushing occupiers to adapt and overcome the perils of COVID 19. Q4 2019 was deemed a superior market to that of its YOY average in 2020. Rather unsurprisingly, 2020 has been riddled with upward trends of increased vacancy, with certain provincial areas being significantly affected when compared to core markets. We make specific reference to areas such as Stratford (2019-7.9% / 2020-9.6%), City Fringe (2019-7.3% / 2020-8.6%) and Docklands (2019-7.8% / 2020-10%). In more core submarkets, Southbank and Midtown experienced the largest change in vacancy within 1.95% — 2.5% increase YoY.
With availability, all bar two submarkets suffered gains on a YOY basis. With positive increases ranging from 1.1% to highs of 3%. The largest uptake was seen in Hammersmith & Chiswick (14.3% — 17.5%) and Paddington where availability has risen from 14.5% in 2019 to 17.8% in Q4 2020.
These upwards growth patterns for both availability and vacancy will no doubt continue, with high levels of construction meeting weak demand. We have seen a continued rise in lease re-gears as many occupiers look to remain in situ due to uncertainty. We have also seen businesses go into administration/ceasing to trade and with the success of home working and London’s dependence on public transport, many firms are delaying their future real estate decisions during this period of general economic uncertainty. The view in Q4 2020 on an immediate recovery in leasing was made less likely by rising coronavirus infections and continued government guidance that workers should continue to operate from home.. A successful vaccine rollout should lead to an uptick in demand from spring 2021 but how long will that last is the question?.
2019 was blighted with Brexit uncertainty within the capital markets, bring on 2020 (or don’t) and COVID 19 was unleashed to really put the market through its paces that bit more. 2019 concluded with a total of £11.9 billion transaction volumes, in comparison to £9 billion totalled in 2020.
The effects of COVID 19 were felt within the market quickly, with only 33 transactions recorded in Q1 2020, a significant decrease from the average 56 seen in other quarters. This carried on to plummet through the next 2 quarters due to lockdowns and travel bans making conditions very difficult for overseas investors to complete on deals and view buildings. However, 2020 made an impressive comeback in Q4 with £1.7 billion transacted during December alone, with a total number of transactions for Q4 of £3.6 billion. This is more than three times the volume that was seen in Q3 2020.
Foreign investment was the major player in the Q4 bounce back market with Singapore’s Sun Venture buying One & Two New Ludgate for £552 million (a 4% yield) and Middle Eastern investor AGC Equity Partners purchasing 1 London Wall Place from Brookfield for £480 million (a similarly keen 3.8% yield). Other major deals that took place through the year included Hong Kong investor Lifestyle International’s purchase of 1 St James’s Square, SW1 from previous owner-occupier BP for £250m, representing a capital value of £2,142 per sq ft.
Construction pipeline in Q1 2020 saw nearly record levels achieved with nearly 45 new buildings being started as confidence soared in the wake of the economy over the last few years, with 5 million sqft of space looking to be created across London. And then COVID hit the world and this figure then reduced to 35 new starts in Q3 2020 with just over 2.5m sqft committed to be being built. Interestingly, two thirds of these new starts are refurbishments rather than new builds.
The big question now is amongst all these new buildings being started, how will vacancy rates change over the coming quarters and years before these new buildings hit the market as this will determine the rental levels that will be quoted. There is a view that rents for prime space will show resilience, whilst tenant stock will show the largest downward shift in rents as more ‘grey’ space hits the market to compete with each other. Unless demand for prime space is reduced through occupiers taking the good quality ‘grey’ space, landlords are unlikely to reduce their quoting rents for their new or refurbished buildings in the immediate future.
On average new start completions have been delayed by 3 months, putting further pressure on landlords to recoup the extra money spent on these projects once completed.
Is now a good time to start a new build with the aim of bringing it to the rising market of 2024/2025?
Whilst the amount of space taken up over the last quarter has dropped significantly when compared to the previous quarters & the 10-year average, we can still see quite clearly which sectors have been performing well.
Predictably leading this is the Financial Services Sector accounting for over a quarter of the space taken in Q4, followed closely by Government & Services with 23% and then a drop down to TMT which accounted for 16% of take up.
The Legal Sector had been within the top 3 sectors for office take-up throughout the year, just dropping out of this in the final quarter, but is still a sector that is performing well & remaining resilient. Coming a very close second to FS in Q3 with Baker McKenzie taking up just over 150,000 sq ft at the impressive DUO Spitalfields. We can certainly still expect the FS & Legal sectors to remain resilient, and with every large scale move there will always be a complimentary movement & increase in take-up close-by.
Looking to the future, it’s important to focus on the sectors that are not only maintaining their structure, but those looking to grow through funding rounds and/or recruitment drives. The top sectors hiring at present are Professional Services followed by Tech in 2nd and then industrials. With the huge investment firms are putting in to software (especially the Education Sector), there’s no surprise that there are a plethora of jobs available to developers.
UK investment & fundraising always surprises, and this got no less exciting in 2020 — a year when the UK secures its status as a Tech Nation welcoming a further 7 new firms in to the Unicorn club & witnessing 39 Megadeals (£50m+) including One Trust, Cazoo & Gym Shark. Investment from PE & VC firms remained buoyant down just 1.56% & 2.5% respectively on 2019 figures. Whilst less money was raised in 2020 down £1.9bn, the number of deals done only dropped from 1,977 in 2019 to 1,957 at the end of Q4 2020.
Taking a more positive stance and avoiding speaking too much about the clear decimation of our great hospitality, travel & retail sectors, there have been some real movers & shakers in 2020. Complimenting the FS office take up, the FinTech sector completed 221 investment deals over the year remaining well ahead. With exceptional demand for healthcare innovation, it is no surprise that life-sciences & e-health grew significantly but the star sector for growth that sees investment sky-rocketing from previous years was digital security.
In the property industry we are often guilty of trying far too hard to avoid talking the market down, but in some situations we need to be honest about what might be coming. The larger firms in particular tend to present market predictions that appear to not be connected to the reality of what is currently happening, particularly when considering the post pandemic trauma that is likely to follow. Perhaps this is an attempt to try and keep the investment and development markets moving, but at some point we need to be entirely honest with ourselves, that this is gearing up to be one of the great recessions. This means that the recovery is unlikely to be fast, unemployment will continue to gather momentum, companies will fold under the strain and there might be deeper impacts that begin to come through. We must consider that there is now a very real chance that in the medium/long term we will see a complete residential crash for the sub £1 million market, and it is very easy for this concept to be dismissed but all things eventually come to an end.
The key to the recovery and the next glorious period of upturn in our industry relies on going through the bad to get to the good. For the time being, we will see some market activity as lease events continue to come through and occupiers try to adapt to the new world. Outside of lease events, occupiers will continue to bring space to the market, across London and reaching levels that run deep into the millions of sq. ft., but obtaining consent will become harder and harder as landlords try to avoid creating negative precedent for future deals/rent reviews. The role of the agent will therefore become more important than ever but we are all going to have to change our tact and as the ancients in property like to say, ‘smell the deal’.
We hope you enjoyed our very first quarterly snapshot. As always, to speak to our team for free advice regarding your workspace, you can contact us at www.SHBRE.co.uk.