Strong office rental value growth to drive investor demand

• Office rents across all submarkets we monitor are to rise over the next five years
• 2020 set to see a surge in international investment into London

Occupiers on the hunt for space earlier

The threat of an impact on business operations through the inability to expand into new office space, or find space that matches planned future requirements has meant that some businesses now begin the search for alternative accommodation far earlier than they have done historically. This has helped to sustain the high volume of prelets, with 52% of the 13 million sq ft of office space under construction across London already spoken for. 

Just 28.3% of all office space completing last year was available to let, meaning those in search of new and refurbished space have a limited selection to choose from. There is currently 4.1 million sq ft of new and refurbished stock on the market. Assuming average take-up levels, this would equate to just under 9.5 months of office supply. 

Some businesses are resigning themselves to the fact that a move might not only be cost prohibitive, but that securing the right space might be a bigger challenge, driving some to regear instead. For others, being location agnostic has become second nature, with anywhere in Central London game, provided the amenities and quality match ever rising expectations. 

How is this impacting the City? 

The City core has benefited from this behaviour to an extent, with West End occupiers now readily considering options in the Square Mile, particularly for larger requirements. Vacancy rates stand at 5.2% in the City, slightly higher than the West End’s 5%, but crucially from an occupier's perspective, City rents are still relatively cheaper than the West End.

However, with businesses readily paying rental premiums for penthouse offices and those with entertainment-scale terraces, top floors in the City’s towers are quickly breaking away from the rest of the prime market, delivering a distinct super prime category of offices. Penthouse office suites in the City have already seen prime headline rents cross the £80 per sq ft mark.

The tightness of supply has also led to rent free periods falling near Elizabeth line stations. And with no imminent relief in sight from the dearth of stock, we expect rent free periods on 10-year leases to tighten over the course of the next five years to 15 months, from 21-24 months now. 

With these factors in mind, we forecast a 20% rise in office rents in the City core over the course of the next five years. This equates to a prime headline rent of £87 per sq ft by the end of 2024, from £72.50 at the end of 2019. 

South Bank rents heading for parity with the City

Across the river in South Bank, another similar story is playing out as occupier interest continues to rise. Relatively lower rents and overall occupational costs mean that this market is becoming increasingly desirable in an environment of rising occupational costs. However, here too, with vacancy rates hovering at about 2.5%, identifying suitable options is a real challenge. 

And with a limited development pipeline, no relief is expected in the near term. This is primarily why we expect prime headline rents to rise from £72 per sq ft today, to £83 per sq ft by the end of 2024, bringing South Bank ever closer to being at parity with the City core. 

West End rents set to cross £130 per sq ft by 2024

In the West End core markets of Mayfair and St. James’s, 64% of stock under construction has already been pre-let. And with availability at 4.4 million sq ft at the end of Q4 2019, down 24% on Q4 2018, supply is tight. This is the lowest level of supply since Q4 2015. 

The availability of new and refurbished stock totalled just 870,000 sq ft, 39% below the long-term average of 1.4 million sq ft. The current vacancy rate in the West End now stands at 5%, compared to a long-term average of 6%.

Looking forward to the development pipeline, there is currently 5.6 million sq ft under construction across the West End. Of that, 2.3 million sq ft is due to complete by the end of the year, however, just 44% is untenanted, which equates to less than seven months of supply, assuming average levels of new and refurbished take-up. 

The sheer dearth of stock in this market underpins our rental growth assumptions, which is why we predict that prime headline rents will rise by 15.7% to £133 per sq ft by 2024, surpassing the current all-time high of £115 per sq ft, last matched prior to the in-out EU referendum. 

Investor sentiment to receive boost

In light of these forecasts, we are expecting investors to demonstrate even more exuberance towards London acquisitions. Indeed our 2020 Knight Frank Global Capital tracker shows that £48.4 billion has been earmarked by global investors for deployment into London over the next 12 months; a 21% rise on the figure for 2018. When combined with current yields of 4.00% in the City and 3.50% in the West End, London still outperforms all other major European centres. 

London was the recipient of almost £14 billion in commercial office investment last year, coming second only to Paris globally. Now with one of the few obstacles to investor caution – political uncertainty – much reduced, 2020 looks set to be a bumper year.