London’s commercial market readies for new post-election chapter

To say that the political uncertainty has hindered the performance of the commercial property market in London is not entirely a true reflection of reality on the ground.

Businesses are continuing to expand and office lease rates are reflecting this, with the volume of office space rented during the third quarter standing at 3.4 million sq ft, which is higher than both Q1 and Q2 2019 and in line with the 10-year average. The resilience of the market has been boosted by continued economic expansion, driven by the tech sector and, perhaps contrary to expectations, the finance and banking sector as well. The latter has added some 18,000 net new jobs to London’s economy since the EU referendum, while the former has added an average of 1,000 jobs each week for the last five years. These core sectors are continuing to underpin demand. 

Office supply driving strong pre-leasing

In parallel, the market remains supply starved and has been for the last 10-years, ever since banks scaled back commercial development financing in the wake of the Global Financial Crisis. The shortage of space also means some occupiers are increasingly footloose and are willing to consider options outside their ‘home’ submarkets, with availability and the quality of space remaining critical decision factors. 

The severity of the shortage is best illustrated through the high level of pre-leasing activity that is taking place while buildings are still being built. In fact, pre-lets are now at the highest level since 2007, with just over 50% of all office space under construction now already committed. 

It remains to be seen whether the rising volume of preleasing in the market is a sign of structural change leading to more build-to-suit developments however, with environmental, social and governance (ESG) issues taking centre stage in boardrooms, issues including workplace wellbeing, a building’s environmental credentials and its amount of flexible space on offer are becoming increasingly important. 

Rental growth to persist

The depth of demand for office space has put upward pressure on rents, with the vast majority of submarkets now experiencing all time high prime headline rents. And with no imminent relief in sight, our forecasts project double digit rental growth over the next five years in most submarkets, with locations like the City Core and Southbank expected to see rent rises in the excess of 20%. In the core markets of Mayfair and St. James’s, prime office rents are forecast to reach £125.00 per sq ft by the end of 2023, from £112.50 per sq ft today. 

London’s global investment appeal

The strength of the occupational market is also continuing to attract the attention of domestic and international investors. Following a weak Q2, investment turnover volumes partially recovered during Q3, falling just short of £2.4 billion, underpinned by a resurgence in interest in London assets, particularly from international investors. 

Despite improved investment turnover levels, total investment recorded is a true reflection of the depth of demand. This is largely down to a lack of stock on the market. During Q3, £2.9 billion was available on the market, spread across 81 assets. This is 21% down on the total for Q2 2019, reflecting the severity of the shortage of openly marketed investments. Potential sellers remain reluctant to bring assets to market in a politically uncertain environment and one where they are also struggling to invest their own funds. Demand for value-add, or refurbishment stock that can take advantage of pressures in the occupational market is especially strong. 

2020 set to see stronger investment volumes

While international investors gather on the sidelines in what appear to be increasing numbers, UK investors have leapt to the top of the leader board for London acquisitions, committing almost £1 billion in Q3, taking the nine month total to £2.6 billion. UK investors clearly sense an opportunity to secure London assets in a less competitive field, even though yields in the City have now recovered the 25 basis point outward movement from the start of this year, to stand at 4.25% for 10-year income. In the West End, there is a lack of transactional evidence to suggest yields have recovered so they remain at 3.75% this quarter. 

Despite the compressed yield in the City, London remains more attractive than many other global gateway locations.

Looking ahead to 2020, we expect to see a marked increase in overseas investment activity, especially as the government continues to message that a conclusion to Brexit may be near. We feel this will be instrumental in unlocking pent up demand as investors are waiting for greater political clarity before committing to London.