The London Series

LONDON

A city forever at the apex of the global city hierarchy.

A city with a long history of rapid reinvention to maintain that global primacy.

A city that has remained a core destination for international occupiers, investors, and global talent.

A city that has long been a safe haven for global investors buffeted by economic and geo-political headwinds.

A city consistently renewed and refuelled by cutting-edge innovation.

A city that will need all these qualities – and more – as we enter the post-pandemic era.

Because there can be no doubt that the London office market – just like its global peers – is undergoing significant structural change. The market orthodoxies and practices that have traditionally served to accommodate London’s growth and make it a crucible for global best practice are under severe pressure. New solutions and new approaches will be required if London is to retain its global pre-eminence as a destination for global occupiers and investors.

Three forces driving structural change

There are three factors generating structural change in the market and altering both supply and demand side dynamics.

First, our experience during - and the subsequent legacy of - the Covid-19 pandemic. The genie has been released from the bottle on flexible working and whilst return to office rates have steadily improved in London since the virus was brought under control, the future of work is undoubtedly more flexible. Our relationship with the office will therefore become more fluid and flexible than ever before. The role of the office is being reinterpreted by occupiers, and that has real implications for existing and future office product, the environment and experience that it presents to its users, and the financial performance of the assets and, ultimately, their owners.

Second, the rise of the ESG agenda and a growing awareness of the centrality of commercial real estate in reducing global carbon emissions, more efficiently utilising natural resources and, hence, positively contributing to the mitigation of the global climate crisis. The ‘E’ of ESG is certainly foremost in the minds of global investors, is of growing concern to blue-chip occupiers and is front and centre of emerging legislative and policy frameworks that have real implications for the economic viability of office development as well as the methods and materials for their construction. However, the agenda is also broadening rapidly, demanding greater consideration of social and governance issues.

Third, a volatile and fragile macro-economic environment as we move further into a post-pandemic era which has seen lower growth projections for longer, rampant inflation and significant spikes in borrowing rates as interest rates moved on quickly from their historic lows. This challenging macro-economic environment is also heavily influenced by on-going geopolitical tensions around the world which add to a sense of uncertainty and vulnerability. More localised dynamics may also have an effect, notably the ongoing instability within UK Government and the prospects of a general election sometime during 2024. These factors have direct implications for the decision-making of investors and occupiers alike, generating caution, inertia and slowing volumes of activity as a more solid foundation for action is sought.

Six essential elements to understanding the future of the London Office Market

The ongoing evolution and inter-play of these three forces pose some real questions for the supply and demand dynamics of the London market over the next cycle. In our view there are six essential elements to properly understanding the future trajectory, positioning and performance of the London market.

1. The relative global positioning of London

   One of the dangers of having long-been at the centre of the global economy is complacency. London’s ability to continually reinvent itself to sustain relevance has never failed. But in the next post-pandemic cycle where are the risks and how can they be mitigated? Moreover, whilst it is natural to be concerned about the performance of the market against its own long-term metrics, how is London performing against its global peers? More importantly still, what are the progressive elements of London’s evolution that might set it apart from the competition and fuel the next phase of its growth?

2. The path to recovery

   London’s rich economic history means that the challenges of the present have, to some extent, been seen in the past. What can we learn from the recovery path that London displayed following previous periods of crisis? Can we identify turning points in market sentiment and dynamics? Which market actors will drive that recovery? The composition of active participants in London’s office market is clearly changing. Long since a destination for global capital, who is in and who is out of the market, why and over what timescale? What is the role of private capital? Where are the opportunities to trade and partner?

3. The change in occupier requirements and behaviour

   The pandemic has upended traditional thinking about work and the workplace. As the office becomes repurposed the quantum and qualities of occupier demand has been called into question. Occupier requirements are changing rather than evaporating. The motivations for taking office space are changing. The pre-requisites that underpin the property decision are different from what has gone before. We are in an age where product trump’s location, where occupiers seek to maximise the efficiency of their own demise and draw more heavily upon amenity and flexibility provided by the landlord, and where offices are so much more than an email processing farm. But as occupier requirements and behaviours change, this directly exposes significant parts of the existing London office market that fail to meet revised and more exacting customer expectations.

4. Understanding what drives office out-performance

   Ultimately, what structural change generates is polarisation. Over the next cycle, London will be a more polarised market in terms of the quality of office product, the viability of future office developments, and the rental and investment performance of those offices. For landlords and investors being on the right side of this market divide is essential. It leads to some fundamental questions about building design, amenity, and how offices can become more than first-class physical environments. It requires evidence about how the provision of environmentally sensitive buildings that are rich on amenity and experience perform in the market. Is the additional capital expenditure and cost of operation – which is no small consideration in the current economic environment – met with an appetite from occupiers to pay, stronger leasing velocity, rental out-performance and stronger asset valuations?

5. Future supply and the retrofitting or adaptive re-use of existing office space

   These new customer demands challenge landlords, particularly given today’s fragile macro-economic backdrop in which borrowing remains costly. Developing new offices that appeal is capital intensive, takes owners into the realms of operational real estate and has many investors questioning the customer’s appetite to pay. The equation for delivering performance has become altogether more complicated and uncomfortable. And the challenge doesn’t end there. As embodied carbon considerations make the delivery of new developments more complex, how can older, physically obsolete office buildings be returned to either office or better-performing alternative uses? What alternative uses most effectively transpose onto traditional office floorplates? With more than half of London’s existing office stock falling foul of MEES standards and effectively unlettable from 2030, retrofitting and adaptive reuse is clearly a big part of the London market response, but how is it achieved, how long will it take, and what effect will that have on both long-term availability and total office stock? Furthermore, where will the capital to drive this upgrading of London’s office stock come from and how will it be rewarded?

6. The sectors and sub-sectors that will act as dynamos for new office demand.

   A flourishing London office market, indeed, a flourishing London, is ultimately dependent upon the attraction of new growth industries and companies who make the city their home. Whilst there are many established companies that will need to reconsider their office requirements when lease breaks and expiries emerge, London’s long-term future is inextricably tied to its ability to attract new high-growth companies from highly innovative sectors. What sectors and sub-sectors will generate these companies? Is it the much-trumpeted AI, other forms of next wave technology? Is the future one shaped by the life sciences and if so what parts of that sector can London excel in globally? Fundamentally, what do supply side actors need to consider in supporting this growth story? Do these high-growth companies have specific real estate or locational requirements? Do they represent heightened covenant risk for the landlord? How can the landlord ensure that they stay the course and benefit from the occupier’s growth trajectory?

The London Series – Bringing clarity through insight

Structural change is challenging.

It presents enormous risks.

It generates vast amounts of noise and a lot of mixed, signals.

Successfully navigating structural change requires clarity. It demands an objective view of the present to enable positive progress into the future. It compels us all to look at the market through a different lens, drawing upon new metrics and new data sources. It forces us to challenge long-standing, tightly held assumptions and be creative in the development of new best practice.

This is the purpose of The London Series.

Through a series of six insightful papers delivered in advance of, during and immediately after our 2024 London Breakfast, Knight Frank will tackle the biggest questions facing the London office market. We will draw upon our unrivalled proprietary market data; our market-leading data scientists and researchers; and our diverse and deeply experience London Offices business to bring clarity through insight to you, our clients.

The first paper in The London Series is out now. It explores the first of our six essential elements of understanding - the relative global positioning of London.

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