NovaLoca Blog

Rents for prime office space in key towns in the southern M25 area are likely to rise as a result of a lack of good-quality stock, says Hurst Warne. Will Gelder, in the firm’s Redhill office, says the economic downturn in 2007 put a stop to almost all new commercial property construction in the area and points out that, with developers struggling to secure new financing during the recession, there is a lack of developments coming through in the pipeline.

Headline rents in nearly all southern M25 towns have fallen since 2007, he adds, after approaching £30 per sq ft before the recession in key towns. There has been gradual take-up of the better-quality available office space as Grade A offices have become more affordable, which means that the supply of Grade A offices in Redhill, Reigate offices and Leatherhead offices is dwindling.

A rise in rents for better quality space in these towns is thus “almost inevitable” in the next 12 to 24 months, the firm says. Hurst Warne notes that two recent deals – at The Heights Business Park in Brooklands and Kia Motors at Walton Green (both £28.50 sq ft) – confirm that “demand for prime space is already pushing rents up”.

Knight Frank has reported a bounceback in occupier activity in the M25 area and M4 corridor offices during the first quarter of this year, but says take-up in the M3 region remains relatively subdued. Take-up in the M25 market was 646,517 sq ft in Q1 2013, the highest quarterly total since Q4 2011 and 20% above the five-year quarterly average, Knight Frank notes. There were 40 deals in this area during the quarter, the most seen in any quarter since Q3 2008. The M25 vacancy rate fell to 7.7% for the quarter, the lowest since Q1 2009, as the lack of speculative development continues to have an effect. But Blackstone began construction of Building 7 at Chiswick Park during the quarter – at 334,000 sq ft, this is the largest single speculative development in more than 20 years, Knight Frank says, and has by itself increased the amount of speculative development in the M25 area by 63%. Knight Frank says M25 take-up activity rose across all size brackets, as occupiers are gaining in confidence and their finances are improving. However, they are facing less choice, says Emma Goodford, head of South East offices, which she describes as “an interesting cocktail” in prime markets with limited stock. She says occupiers are continuing to focus on the best quality space, which is encouraging landlords to reposition buildings in those markets where a shortfall in supply is putting upward pressure on rents. “The West London markets of Hammersmith, Richmond and Chiswick are performing fantastically, with prime rents reaching record highs in 2012. With new and Grade A supply set to tighten further along the Western corridor, evidence suggests that concrete rental growth will spread to other key markets” this year, she says, such as Staines offices, office space in Maidenhead and Uxbridge office space. In the M4 corridor, take-up reached 426,377 sq ft, which is a rebound of 46% from the previous quarter’s subdued total and the sixth strongest quarterly total seen over the past five years. The vacancy rate in this area is now 9.8%, down from a peak of 12% two years ago. Activity in the M3 region, however, was 7% below the five-year quarterly average in Q1 2013 at 179,616 sq ft. This is 20% below the 10-year quarterly average.

The Manchester Office Agents Forum says occupier activity in the first quarter of this year has strengthened considerably compared with Q1 2012. There was a significant uplift in the levels of take-up of office space in Greater Manchester and in Warrington offices.

In Manchester city centre offices take-up totalled 274,800 sq ft in the first quarter, up 61% year-on-year, across 64 deals. The number of transactions is only slightly higher than last year (61) but the average deal size has increased, with six transactions of more than 10,000 sq ft in Q1 2013 compared with only three of this size a year ago.

Other regional submarkets monitored by MOAF also saw increases in office take-up. South Manchester offices take-up rose 61% year-on-year to 219,286 sq ft, while in Warrington Q1 office volumes jumped 120% to 93,129 sq ft. The Salford Quays and Old Trafford markets saw volumes rise 4% to 52,894 sq ft.

Greg Ball of Jones Lang LaSalle, spokesperson for MOAF, said there had been a good mix of inward investors as well as companies already based in the region who had sought additional space for growth. “This activity points to improving sentiment and confidence amongst occupiers during what remains a challenging market,” he added.

Central London commercial property remained highly attractive to international investors in the first quarter of 2013, says Cushman & Wakefield, which has calculated that a total of £2.75bn was transacted, with overseas investors accounting for 71% of this. The total volume was down almost a third from the £3.98bn in the final quarter of 2012, which Cushman & Wakefield says reflects a lack of available Central London property. This particularly held back volumes in the West End.

Transactions involving City property and property in the Docklands reached £1.77bn in Q1 2013 across 22 deals, with overseas investors accounting for £1.56bn of the total. The average transaction size was dramatically smaller for the 13 UK investor deals done, at just £16m, compared with an average of £175m for the nine deals done by overseas investors. This reflects the fact that four overseas transactions accounted for 75% of overall volume, amounting to £1.35bn. These were the purchase of Ropemaker for £472m (5% Net Initial Yield); St Martins (KIA – Middle East) acquisition in Canary Wharf of 5 Canada Square for c.£383m (5% NIY); Ivanhoe Cambridge’s (Canada) purchase of Woolgate Exchange for c.£265m (5.95% NIY) and Deka’s (Germany) Southbank acquisition of Palestra for £225m (5.1% NIY).

Bill Tyser, head of City investment at C&W, says that while there are some concerns about the lack of available stock to meet intensifying demand, “there are also signs of profit-taking emerging from investors who acquired property at the beginning of this ‘crisis cycle’.”

In the West End, turnover reached just £965m across 33 transactions, down from £1.21bn (40 deals) in the final quarter of 2012. Demand for West End property remains strong, with more than £400m of investment stock understood to have exchanged by the end of Q1 2013 and another £1.46bn under offer. Overseas investors accounted for more than half of the purchaser volumes in Q1 2013.

Mike Tremayne, head of West End investment at C&W, says overseas and domestic investors alike are seeking to benefit from the “underlying positive occupational demand, strong liquidity and general ‘safe haven’ qualities the West End has to offer”.

The subdued outlook for traditional finance-sector employment in the City of London is raising important questions for landlords, investors and developers, says DTZ. Financial sector headcount is forecast to be broadly flat over the forecast period to 2017, with slow or no growth in employment the ‘new normal’ for this sector, the firm notes. Take-up of City office space by the financial sector fell last year to the lowest on record. This has been partly offset by rising demand from the TMT and insurance sectors, the legal sector and other professional sectors, and this trend will continue, to lead in the longer term to a more balanced pattern of demand and a broader tenant base in the Square Mile. However, DTZ does not expect this to be sufficient to restore take-up to previous highs. The firm forecasts average take-up of 4.4m sq ft during 2013-2017, in line with the level experienced since 2008. Despite the subdued take-up level, DTZ expects prime rents for City offices to remain stable in the near term, and to rise to £65 per sq ft by 2017, in a reflection of the limited supply available, both new and secondhand. Importantly, the firm expects prime rents for Midtown offices to overtake for City office space thanks to the very limited supply pipeline, lower availability and strong demand from TMT occupiers in this area of London.

Cushman & Wakefield says leasing activity in the market for office space in Central London is being driven by occupiers seeking more value for money. The firm says the balance of power remains in occupiers’ favour, with larger companies, in particular, taking the opportunity to “drive a hard bargain” and secure maximum value from landlords. C&W highlights the purchase by Google of 800,000 sq ft of Kings Cross office space for its new UK headquarters, which boosted overall take-up of Central London offices to 2.1m sq ft during Q1 2013 – significantly above the previous year’s first-quarter total of 1.5m sq ft. The Google transaction also made a significant contribution to the West End’s total Q1 2013 take-up of just under 1.3m sq ft – more than 75% ahead of Q1 2012. The media and technology sectors were responsible for 63% of West End offices transactions completed in the quarter, the firm notes. Guy Taylor, head of West End office agency at Cushman & Wakefield, says occupiers are broadening their search criteria as they seek good-value office accommodation. Meanwhile, in the City and Docklands, take-up reached 815,000 sq ft in the first quarter of this year, which is 13% above the Q1 2012 total. Here too occupiers are taking the opportunity to negotiate value from landlords. C&W says the insurance market was the most active City offices market in the first quarter, accounting for 18% of lettings. The Central London deal pipeline looks “promising”, says C&W, with about 1.9m sq ft currently under offer, broadly in line with the five-year quarterly average of 2m sq ft. Of this total, the City has 1.6m sq ft under offer, with 345,000 sq ft in the West End. The significant amount of space under offer in the City – 40% ahead of the five-year quarterly average – is partly driven by landlords of buildings with substantial letting voids being ready to offer “very attractive” financial terms in order to secure prospective occupiers, says Andrew Parker, head of city agency at C&W.

Jones Lang LaSalle expects UK property returns to improve to 4.6% at the All Property level in 2013, compared with 3.4% in 2012. Returns over the five-year forecast period reach 6.2%, but this is lower than the long-term average. The firm’s latest forecasts show that rental growth is expected to remain weak overall this year, apart from London office space. JLL forecasts that economic recovery will bring an upturn in rental growth from 2014, but even then it expects increases to lag behind inflation in the longer term. Office property will produce the strongest returns over the five-year period, says Jones Lang LaSalle, at an average of 7.1% per year. Central London offices lead the way and the large gap between the performance of property in the capital and the rest of the UK is set to continue. Industrial property returns are forecast at 6.2% for the five-year forecast, with distribution warehouses expected to produce a stronger performance than standard industrial space. The retail sector’s returns are forecast to remain weak until 2015 when a solid recovery is in prospect as the economy also gains strength: until then, returns for the sector are expected to be dragged down by the shopping centres subsector. All Property IPD rents are set to remain broadly unchanged in 2013, with offices the only sector forecast to record rental growth this year. Retail rents, which fell last year, are forecast to remain stable in 2013; retail warehouses are expected to perform more strongly than other retail subsectors, with rental growth averaging 1.7% per year over the forecast period, but for the sector as a whole the five-year forecast average remains firmly below its long-term trend. Mark Jones, director of strategic asset management at JLL, noted that the firm’s latest forecasts “still show UK direct property delivering a real return over five years of under 5% per annum,” although he added that the strong variation in performance between Central London property and elsewhere in the UK was set to continue.

Jones Lang LaSalle has published a new report: ‘From Obsolescence to Resilience’, showing that while the property industry faces a problem with depreciation and obsolescence, investors and occupiers can gain value through strategic refurbishment and proactive asset management strategies.

The firm has identified three critical factors that raise the risk of obsolescence and accelerate the depreciation of a property asset: legislation; corporate requirements; and workplace technology. Investors and developers must adapt quickly to these risks if they want to maintain solid asset performance, Jones Lang LaSalle says.

The UK Energy Act 2011 makes it unlawful for landlords to lease space and for occupiers to assign or sublet buildings rated F or G from April 2018. Mike Tiplady, director of project and development services at JLL, says there will be value depreciation on obsolete stock as this 2018 deadline approaches, with poorer-quality product likely to have longer void periods, lower rental growth and higher rent-free periods. “Now more than ever, sustainable refurbishment and proactive asset management will be required, with an opportunity for the investment savvy to mitigate these risks.”

Meanwhile, the increased sophistication of corporate occupier requirements mean that office property needs to become sufficiently flexible to incorporate changing technology requirements, and floorplates that can adapt to more collaborative configurations. Buildings that fail to enable corporate preferences will become obsolete for the larger user, JLL warns.

Karen Williamson, senior analyst for UK research at JLL, points out that office building replacement rates across Europe are only 1%-2% a year, which is “nowhere near enough to keep obsolescence at bay”. With finance likely to remain limited for speculative development in the medium term, she feels there is great potential for investors to access “challenging, but appropriate stock” and refurbish it, provided that it is economical to upgrade. She adds that innovative funding partnerships could be formed with occupiers to open up finance for refurbishment, while buildings that become fully obsolete could find alternative uses.

Take-up of office space on business parks in the UK reached 1.9m sq ft during the second half of 2012, says GVA, which is in line with the six-monthly average but down from the 2.5m sq ft recorded for H1 2012. The strongest activity was in the South East, Midlands and North West.

The vacancy rate for business park offices has risen slightly to 19.3%, with strong variations between regions. In prime locations such as the M42 and South Manchester vacancy rates are falling, whereas elsewhere they are increasing. There has been a marked increase in demand for the Birmingham out-of-town market, GVA notes. Overall availability has now started to plateau after rising significantly in recent years, says GVA: it totalled 18.5m sq ft at the end of 2012, which was 0.7% more than after the first six months of the year.

Given the high level of vacant, available office space on business parks, there are only a handful of such properties being built at the UK, totalling 470,000 sq ft – 90% of which is pre-let, GVA notes. However in the South East, Blackstone has recently announced that it will begin speculative development on the 334,000 sq ft final office building at Chiswick Park. While GVA expects overall levels of development activity to increase, it says this will partly be for hybrid research/office buildings rather than pure office space, and will reflect low-risk pre-sales or pre-funded pre-lets.

Landlords, seeking to avoid void costs and refurbishment costs, have increased their freehold sales to existing occupiers. Freehold sales still make up a small proportion of transactions, but are rising, and occupiers are taking advantage of favourable values. GVA thinks this trend will continue but that prices are now likely to stabilise. It notes that landlords are also reducing the risk of void costs by offering more flexible leases with shorter terms in order to retain tenants. However, demolition is an option in some areas “and will continue to be so, particularly where higher-value alternative uses can be brought forward”.

The TMT sector, encompassing broadcasting, publishing, new media, advertising, marketing, PR, information technology, telecoms and media occupiers, continued to take a rising proportion of Central London office space last year, accounting for 22% of the total taken up by the end of 2012 compared with 20% in 2011, notes Jones Lang LaSalle.

Although the sector has thus overtaken the traditional banking/finance sector, Jones Lang LaSalle says it is uncertain whether this can be sustained. “For every Google or start-up there is a technology mammoth that is challenged and potentially downsizing,” it cautions. “What might be more telling over the long term is the continuing interplay and blur of technology and media firms, the associated changing space needs and also ongoing pressure to consolidate currently fragmented portfolios, particularly in the media sector, over the long term.”

Most (49%) of the existing demand from TMT occupiers comes from companies that are seeking expansion space, JLL says: there are 12 companies with expansion requirements, nine of which are ISPs and general internet-based services or software houses & data processing, and three of which are telecoms requirements. Companies with forthcoming lease expiries are also generating steady demand.

TMT occupiers are sensitive to the quality of space, which needs to offer the potential to aid creativity, and also sensitive to cost – there are only a few major companies such as Apple or Google that can pay top prices, the firm notes, whereas most are not cash-rich and would rather spend in core investment areas rather than on real estate.

Despite a lack of good-quality supply and rising rents, Soho, Noho and Covent Garden remain the preferred submarkets for advertising and media companies, JLL says, but activity has been increasing in areas such as King’s Cross, Shoreditch, Farringdon, Old Street and Clerkenwell. These areas are increasingly attracting larger occupiers, drawn by the possibility of synergies with the smaller start-ups that have already located there.