London's Office Rental Market: 2016 Overview
During the first half of the year, the office rental market in London was characterised by its strong performance. However, as months went by, the most widely discussed theme was the effect of the EU referendum on the local property market, and in particular on the office sub-market, given that many banking and finance firms suggested they may consider relocating in the event of the loss of passporting rights.
Despite the initial uncertainty, during the second half of the year and following the referendum, the so-called Brexit effect has not had an immediately noticeable impact on the London office market, mainly due to large number of pre-lets that had been agreed prior to the referendum. In fact, under-supply continues to be predominant theme in all Central London sub-markets, and particularly in Midtown, the West End, and South Bank. Analysts at Carter Jonas affirmed that while the City and the Docklands were the most likely to be affected by a potential Brexit-fuelled occupier migration to other banking and financial centres, dramatic rental value drops are unlikely, as other industry sectors will remain unaffected (1).
Key Market Indicators
During 2016, vacancy rates have remained at around 4 per cent across all sub-markets with the exception of St James, Clerkenwell, and Holborn (2). Take up volume was at its highest in the City, with 43 per cent of the total, followed by the West End and the Docklands (3). During the first half of 2016, rental values for Grade A space in the City increased by 14 per cent on a year-on-year basis, and in some locations (Blackfriars and St Paul's) the increase reached 25 per cent. Elsewhere, office rents have risen the most in Farringdon, Clerkenwell, Finsbury Square, Aldgate, Tower Hill, Spitalfields, Blackfriars, Barbican, and Liverpool Street, whereas the areas least affected by price increases are Docklands, Holborn, and Bloomsbury (4).
Towards the end of Q3, the highest per-square-foot rates were in Mayfair, St James, Knightsbridge, and Marylebone, averaging £125 / sq ft across the West End. The second highest rates were in the City, ranging between £60 and £93 / sq ft depending on whether space is new, refitted or in upper floors. At the lower end of the scale, we find properties in the Docklands, Chiswick, Aldgate, and Shoreditch, where asking rents range from £33 to £53 / sq ft for new or refitted office space (5).
Under-supply has not only put pressure on rental values, but also on lease terms. Rent-free periods are becoming shorter and harder to negotiate in market conditions that clearly benefit landlords. The standard rent-free period for 5-year lease agreements in the City are 10 months (8 in the West End), whereas the most generous rent-free terms usually apply to properties in the Docklands, Spitalfields, Aldgate, and prime City locations (6).
There are upwards of 5 million square feet of office space in the London development pipeline. However, properties will only be completed within the next 18-24 months and mainly in EC2, EC3, King's Cross, Victoria, and South Bank. In the meantime, rental values are expected to rise steadily, reaching £80 / sq ft in the City, £150 in the West End, £73 in South Bank, and £76 in Midtown by early 2018. Moreover, properties in the Paddington sub-market may attract premiums once the Elizabeth line is completed in 2018. On the whole, rental growth is expected to flatten for the remainder of the year and to later increase by an average of £3 / sq ft / year (7). Rent increases in prime locations may also result in a substantial migration of firms towards eastern and southern fringe markets, prompting a decrease in availability rates in those areas.
If Brexit materialises, weaker demand from certain sectors may make the market more favourable to tenants, resulting in flexible terms and more generous rent-free packages. Although Brexit may have a negative effect on the office investment market, researchers agree that the effect may not translate into a weaker rental market. According to Colliers International, office rental values across London are set to grow by 1-2 per cent in the West End and the City over the 2016-2020 period. Their forecast also draws attention to the fact that banking and finance are not the most active drivers of demand in the rental market, since media, tech, and business services play a far more important role (8). On the whole, both occupiers and landlords are likely to go through an adaptation period over next 2 years, during which we are likely to witness some changes to the occupational market, including an increase in demand from the legal, accountancy, insurance, and business services sectors (9).
(8) http://www.colliers.com/-/media/files/emea/uk/research/research and forecasting/201609_reifq3.pdf?la=en-GB