Commercial Insights - London: A quieter market.

What we know

Leasing decisions being deferred. 10-weeks into the COVID-19 crisis and the market is starting to become quieter. Pre-letting activity that was in train prior to the lockdown is for the most part still completing and new requirements have been slowing for a number of weeks as businesses have been spooked by the very real threat of a prolonged period of economic contagion. We do however appear to be approaching an inflection point, with a small pick-up in new demand. Although it is too early to quantify the exact figure, these new requirements are different. The businesses looking for new offices are typically seeking approximately 75% of the space that they were previously – to accommodate home working. Since 17 March, there have been 106 lease transactions, totalling just over 700,000 sq ft, with 3.55m sq ft under offer. It is unlikely that all the space under offer will transact before the end of the quarter, suggesting Q2 will see leasing volumes on par with Q1, if not lower.

Rent holiday requests ebb. For now, rent holiday requests, or rent deferment appeals via the government’s Corona Virus Bill appear to be subsiding. This could be reflective of the fact that we are now halfway through Q2, with a resurgence likely as we approach the end of June. Prime headline rents for best-in-class space are still holding steady, with almost no instances of attempts to chip rents for grade A space. Lease incentives, however, have drifted: 21-24 months on some 10- year leases, instead of 18-21 months in the West End and nearer 24 months in the City, which were previously at 21-24 months.

"We do appear to be approaching an inflection point, with a small pick-up in new demand."

What we expect

The shortage of grade A office space will persist. As occupational demand begins to recede amongst certain occupier groups who are taking a “wait and see” approach, the extended completion time-frames mean that the supply-demand dynamic which has shaped London’s office market since the Global Financial Crisis (GFC) is being prolonged, shielding the market from a potential glut of new stock. In fact, even if take-up levels for new and refurbished space were to fall to levels not seen since the GFC this year, London would still be looking at a development shortfall of new and refurbished space of almost 1m sq ft in 2020.

Private wealth to become a key player in the market. Not hamstrung by the politics of shareholder approvals, we expect to see greater activity from private investors. Indeed, our own sentiment indicators have shown a rise in international buyer inquiries over the past fortnight, especially those from Greater China. That said, despite sterling’s weakness as the dreaded B-word (Brexit) returns to haunt UK plc ahead of a potential no-deal scenario by year-end, rapid deployment will be hampered by a number of other critical factors: lack of debt options, a dearth of stock, greater scrutiny of any underlying covenants and perhaps to a lesser extent, global travel restrictions.

What we question

A rapid return to “normal”. With the government easing lockdown restrictions, optimism is running high for a rapid return to “normal”. However questions remain about the ability of offices to re-accommodate their workforces safely, in our new world of social distancing, which, among other things, requires 135 sq ft per desk based worker, according to our estimates. If this is extrapolated, in theory, the West End emerges as the most generous market, with an almost consistent 160 sq ft apportioned to staff over the last five years. The City, at 126 sq ft per employee, outperforms the Docklands, where the figure stands at 104 sq ft per person, 23% below the minimum threshold to maintain social distancing.

In theory, if we factor for office stock due for delivery this year, which is not already spoken for, this would equate to an immediate requirement of 6.1m sq ft and 4.4m sq ft, respectively. Rather than committing to new space to accommodate their workforces, it is likely that businesses will instead turn to the flexible office market as a stop-gap solution due to the short term nature of commitments. This will likely come in addition to a more permanent adoption of a working-from-home (WFH) dynamic as working practices are reviewed in light of the effectiveness of technology in sustaining productivity across a largely remote workforce.

Notwithstanding mobility challenges stemming from the government’s estimate to run our rail networks at 10% capacity to maintain social distancing, the design and layout of offices will need to be revisited as businesses reassess how best to house their staff in safe and secure environments. Indeed with natural materials, such as wood, brass and copper, emerging as unfavourable for the surface transmission of COVID-19, the combined wellness and green agenda that was accelerating before the COVID-19 crisis will likely experience a further surge in interest as the focus shifts to the “S” and “G” in ESG considerations.

In parallel, as businesses work hard to tempt the workforce back into offices, workplace wellbeing, and world-class experiences will become sharper areas of focus. This is especially pertinent in London where 64% of our office stock was completed prior to the year 2000. This creates a tremendous opportunity to upgrade existing facilities to meet the needs of our new post-COVID-19 era.