London's Office Rental Market - 2019 Outlook And Trends

London's office rental market ended 2018 on a strong note. Towards the end of the year, the city's market evidenced record-high take up levels (which in fact were the highest since 2010), as well as low availability rates across the board, which signalled strong demand and a high level of transactions (1).

Moving into 2019, the overall outlook appears to be mixed: while a generalised decline in rental values is evident and this trend is even more marked in mid-range offices, availability rates are low and expected to reach record-low levels in some areas (2). A forecast report published by Carter Jonas outlines the five trends that are most likely to emerge in the London office market between now and 2020 (3):

- Stable rental values across South Bank and Midtown, mostly caused by low availability. The exception are high-priced offices in prime West End areas, like St James and Mayfair, where rental values are likely to drop as tenants seek more affordable alternatives elsewhere.
- Declining rental values in the City of London, City Fringe areas, West London, and the Docklands.
- A slight rise in rental prices along with declining availability in West End offices.
- Little to no change in the length of rent-free periods, outside of offices that have been vacant for a while in the West End, City, City Fringe, and Docklands.
- The development of a two-tier market, with Grade A offices (including those refitted) outpacing all other properties. By contrast, secondary office space is expected to move at a much slower pace, and vacancy rates for these properties already account for 75 per cent of the city's total vacancy rate (4).

According to this report, most noticeable rental price increases will take place in Holborn (up to 3.8 per cent when compared to 2018 prices), Victoria, Paddington, and Farringdon (all above 3 per cent). The biggest price drops will affect areas like the City (both in prime and secondary sub-markets), Canary Wharf (with drops of up to 5 per cent), Aldgate, and Spitalfieds. In the remaining sub-markets, both rental rates and demand are expected to remain stable, at least during the first quarter of 2019.

In terms of availability, tenants may have a wider range of choices in the eastern areas of central London, where the amount of available office space can be more than twice as high than in other areas of central London. Other areas to consider include:

- The City, which has London's largest office development pipeline and some deliveries planned for 2019.
- South Bank, one of the key areas to watch during 2019 due to ongoing and strong demand office space.
- New or refurbished offices located along the Elizabeth Line, which are expected to experience some of the highest rental growth rates during 2019.

Which factors will affect London office rentals in 2019?

The uncertainty generated by the outcome of Brexit is one of the most important factors affecting the performance of the London office market (5). The general assumption is that the market will be stagnant during the first quarter of the year, and that rental values could decrease by an average of 3 per cent, which would make the market more amenable to tenants looking to establish themselves in London. However, strong fundamentals and the market's status as one of the most robust in the world may make it easier to weather the slow start of the year (6).

Another factor to bear in mind involves the lease accounting regulations known as IFRS 16, which came into effect on 1 January 2019. The implications for commercial property leases are likely to impact the way office occupiers view real estate options, making them more inclined to look for alternatives to long-term leases in order to minimise liabilities (7).

A third factor involves specific industry sectors that have proven resilient to uncertainty and are likely to grow their operations in London. This is the case of technology in general and of big multinationals in particular (8). During 2019, office market performance is to continue being driven ahead by the technology and professional services sectors in a reflection of wider economic trends, which confirm that banking and finance are no longer the main occupiers in the city's commercial real estate market. This trend may become more pronounced due to the quick changes taking place in the tech sector (mainly related to artificial intelligence and Internet of Things) which could underpin a spike in demand for office space across London (9).

Lastly, there is the unstoppable growth of flexible and shared office space. During 2018, demand for this type of office space became consolidated, and by the end of the year, more than 10 million square feet of shared office space had been taken up (10, 11). The trend is expected to continue into 2019, boosted by the growing interest of international coworking providers in the city. In terms of the occupier profile, current trends point towards large businesses and corporates increasingly leasing this type of space, and some estimate that their numbers could easily match those of independent contractors, freelancers, and owners of small businesses. Beyond 2019, flexible space solutions could become a direct competitor to traditional office space (12, 13).