Impact of tenant release space expected to be localised at a submarket level

• 3.1 million sq ft of space was released by tenants during 2020
• The impact of tenant release space on the market will be driven by the quantum of space, but more importantly by the quality of that space, as well as its location
• Despite tight supply, we predict that occupier attention will remain laser focused on the very best offices, with tired stock likely to experience a dearth of demand

How much is too much tenant release space?

The potential glut of tenant release space has been a significant area of concern since the start of the Covid-19 pandemic, particularly the impact of poorer quality stock on both rental performance and market sentiment.

We have been tracking tenant release space since March last year and the current total stands at around 3.1 million sq ft. Of this amount, some 590,000 sq ft was planned pre-pandemic. In previous years, the volume of tenant controlled space on the market in any given year has typically been around 3.5 million sq ft, so during 2020 we remained below this level. However, this is where the quality of stock factor comes into play: just over 50% of tenant release space falls into the Grade B (or lower) category.

“We expect poorer quality offices to be almost entirely discounted by occupiers, unless refurbished to a new modern standard.”

We expect much of this space to be discounted by occupiers, unless refurbished to a new modern standard. Furthermore, the increasing focus on prime office space that delivers on flexibility, quality, and aids ESG goals means poorer quality stock will face challenges in attracting interest. The alternatives are to risk the long road to obsolescence, or perhaps even a change of use. A bigger risk stems from the impact to sentiment from the volume of space released into any one submarket.

Victoria to feel greatest rental pressures?

Victoria, for instance, which accounts for 14% of all space ejected by tenants will likely see greater downward pressure on headline rents. However, with 40% of tenant release space in this submarket classed as Grade B the challenge for landlords is clear: barring significant refurbishments, some of these Grade B offices will simply be unlettable.

Some landlords are alive to evolving market expectations and one of the largest single lots of space in Victoria – the 100,000 sq ft John Lewis building – was withdrawn from the market at the end of last year while the owners assess how best to reposition the asset before returning it to the market.

Elsewhere, Fitzrovia saw just over 16% of its tenant release space reabsorbed in a single deal when Netflix committed to 87,000 sq ft in the Copyright Building. Looking at London overall, this accounted for 2.8% of all tenant release space and 8.2% of space in the West End. This example underscores the very localised impact of tenant release space; a trend we believe will be echoed in other markets around London.

Our view is that the impact of tenant release space on the market will clearly be driven by the quantum of space, but more importantly by the quality of that space as well as the location. This will mean that any impact is likely to remain local to submarkets, rather than being felt across London.

How does this crisis compare with the global financial crisis?

It is still too early to begin assessing the current rate of reabsorption of tenant release space due to the limited number of examples. However, we have examined data from 2008/09 to get a better understanding of the rate of reabsorption at that time, as a guide.

The biggest increase in overall availability in London happened in Q1 2009, which registered a rise of 22.8%, taking total availability to 22.3 million sq ft. This comprised a 23.2% rise in new and refurbished stock, with a corresponding 22.5% increase in secondary space, equating to availability of 7.4 million sq ft and 14.9 million sq ft respectively. Zooming in on the availability of secondary space, of the 10,029 available listings, just 7 schemes had space of over 100,000 sq ft while 33 were for space between 50,000 and 100,000 sq ft. By far the biggest majority (995 listings) were for space under 5,000 sq ft.

“Despite the tightness of supply, it is our view that attention will remain laser focused on the very best offices.”

Excluding space that was first refurbished, or withdrawn altogether, the average time to fully re-let tenant release space in excess of 100,000 sq ft was 6.8 quarters. The quickest re-let – just two quarters – was the 185,757 sq ft Trinity Tower building at Thomas More Square in St Katharine Dock.
Separately, offices of between 50,000 and 100,000 sq ft took an average of 7.8 quarters to be full reabsorbed into the market.

While the pace of re-lets during the global financial crisis may offer landlords and investors some comfort, the quality of stock factor cannot be understated. And despite the tightness of supply, it is our view that attention will remain laser focused on the very best offices, with tired stock likely to languish.

Read: Supply shortage set to define the 20s