What we know 

Leasing KPIs point to slowing activity. The depth of market activity sustained throughout 2019 persisted well into Q1 2020, however the unravelling of global growth due to COVID-19 began to erode market sentiment in early March. This, in tandem with restrictions being introduced on building access and a full lock-down eventually inhibiting the ability to view space, led to total office take-up ultimately dipping to around 2m sq. ft. in Q1, down on Q4 2019 (3.4m sq. ft.). The long term quarterly take-up average is 3.3m sq. ft.

In the six weeks since 16 March, almost 650,000 sq. ft. has been let. There is also over 1.4 million sq. ft. worth of office space currently under offer, suggesting take-up in Q2 could reach 2.05m sq. ft., up on the 2.0m sq. ft. figure for Q1 2020. There is also 3.7m sq. ft. worth of office space currently under offer.

Cash flow pressures stemming from slowing economic growth have resulted in a rise in rent holiday requests, a trend picked up by our own sentiment indicators. The COVID-19 pandemic happens at a time of record high rents in all submarkets, so this is perhaps unsurprising. Prime headline rents are however holding steady across the board, underpinned by a chronic shortage of grade A space heading in to the COVID-19 crisis. Lease incentives are starting to move out: 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.

The government’s emergency Corona Virus Bill grants a moratorium on forfeiture until 30 June, which offers some temporarily relief. The Bill effectively means that tenants are not obliged to pay rent for the next three months. They are however still liable for the missed rental payments in the future.

As a result of this and financial pressures, there have also been a number of instances of non-payment of rents, circa 20-30% of businesses. Partnerships between landlords and businesses will be critical at this time as they work together to develop new payment plans and timelines. Indeed we have seen landlords responding positively to requests for deferring rental payments, albeit many are also asking to see evidence of financial stress.

Separately, viewings have slowed substantially, but are still being undertaken virtually, particularly on prelet stock where marketing campaigns are now fully supported by digital fly through presentations, enabling occupiers to progress option review and due diligence elements of searches. Nonetheless, leasing activity is expected to be heavily constrained until social distancing guidelines are eased. Interestingly, with lockdowns being eased to some degree in other cities in Asia and the Middle East, we are increasingly in dialogue with landlords and businesses around safety measures that will be needed once the UK begins to ease its lockdown.

All investment deals are being reviewed. As the COVID-19 crisis bites, investors’ default position is to put acquisition efforts on hold until stability returns. Lenders are assessing their portfolios and exposure to struggling businesses with very few in a position to consider new business just yet. Our sentiment indicator continues to show global interest in the London market as many see this as a potential opportunity to secure stock at reduced prices, but few are able to commit now. Meanwhile, there are few signs of any distressed sales at this point.

Data for Q1 shows investment turnover of £2.6bn (LTA: £3.4bn), much of which occurred prior to the lockdown. There has been c.£400m of London office investment transactions exchanged since the lockdown, but transactions are largely limited to those that were marketed prior, as access to new opportunities is very restricted. Q2 turnover will undoubtedly be very limited.

From a positive perspective, investor sentiment about the market fundamentals in the medium term remain broadly positive, and there is a clear build-up of pent-up demand that should be released once some certainty returns. Overseas investors are already becoming more active, at least in terms of enquiries, with those parts of the world that are leading the recovery from COVID-19 lockdowns – principally Asia and parts of Europe – leading the trend.

What we expect

Flexible offices will offer stop gap solution to businesses. There is no doubt that there are some concerns for the flexible office sector. Operators are dependent on daily traffic and will be most impacted by the ongoing situation surrounding COVID-19. There are already many reports in the press showcasing a large list of well-known operators who are asking landlords for rent discounts or holidays. Those with greater exposer to corporate enterprises, i.e., businesses with over 500 staff, are likely to fare better given the longer lease commitments. 40% of WeWork’s tenant base is comprised of businesses that fall into this bracket, for instance.

Once businesses begin the transition back to the workplace, flexible offices will likely play a vital role in providing short term solutions to those occupiers who are caught out by construction and fit-out delays. Our Flexible Office Solutions team has already experienced a rise in such queries.

Furthermore, like some markets in Asia, flexible offices can offer a short term remedy to businesses looking at their staff density ratios in the wake of COVID-19, as social distancing rules become part of the new normal, not least due to the advantages of securing short leases for plug-and-play space.

"We expect London real estate to re-emerge as a global safe-haven, particularly for investors focused on wealth preservation and income."

Tenant covenant positions are under increased scrutiny. Investors now need to scrutinise from a different perspective to previously, focusing more heavily on the underlying financial health of businesses before making an investment decision. The result? Depending on the depth of any economic contagion from COVID-19, tenants exposed to those business sectors most affected by the virus shutdown will demonstrate softer yields, relative to the rest of the market.

We expect London real estate to ultimately re-emerge as the global safe haven, as has been the case historically, particularly for investors focussed on wealth preservation and income generation in markets away from their own ailing home economies.

What we question

The belief that headline rents will weaken. Prime headline rents were already facing further upward pressure, prior to the COVID-19 crisis, due to the restricted development pipeline and continued pre-leasing dynamic further eroding the future supply of stock. Construction delays will only exacerbate the underlying supply shortage of prime office space across London. Undoubtedly, rents will come under pressure as demand is stymied, particularly in Q2 and Q3. We expect to see the lockdown easing in the summer, which will help to reinject both confidence and activity in the market.

Six weeks into the lockdown and after a period of battening down the hatches, some occupiers are re-emerging, undertaking due-diligence and planning for a return to the office. With that in mind, we are of the view that prime rents will likely end the year at more or less the same level at Q1.

Secondary stock however is unlikely to enjoy the same level of stability, with the rental tones in this segment of the market likely to adjust downwards, further widening the gap between prime and secondary space.