29 January 2015, The Search for better value, and the continued migration east, will be the dominant themes for office tenants during 2015.

Businesses with offices in Central London that are seeking to expand or relocate will face serious challenges until at least 2017/18 when it is anticipated that a more even balance between supply and demand is restored in the Capital and the current wave of office developments reach completion, according to Carter Jonas’ recently published research document “Central London Office Market Update Q1 2015 – Guide to Office Rents and Rent Free Periods”.

Development funding and demand for Central London office space dried up in the wake of the 2008/9 global financial crisis.  The extraordinarily low office vacancy levels that are prevalent throughout Central London today are a direct result of the virtual absence of speculative office development starts during and immediately following the banking and sovereign debt crises. As a consequence, tenants are currently facing limited choice, rising rents and shorter rent-free periods.

Michael Pain, head of Carter Jonas’ Central London Tenant Advisory Team said:
 
“Rents for new Grade A office space located in areas such as Victoria in the West End have increased by up to 14% and by up to 13% in the City core since the first quarter of 2014 and similar increases are likely over the next 12 months, driven by unprecedented low vacancy rates. The dominant themes for tenants during 2015 will be the search for better value and the continued migration to lower cost areas such as the City fringe, South Bank, Docklands, Paddington and Stratford.”

The impact that the current pipeline of office developments is likely to have in curbing rental growth in Central London is likely to be constrained given that many projects that are currently under construction are being let prior to completion. As demand increases and vacancy levels fall, an increasing number of tenants are implementing their office searches earlier than would ordinarily be the case and are entering into pre-completion letting agreements in order to secure operationally suitable office space ahead of their lease expiry dates.

Michael Pain said:  “In an office market where rents are likely to continue rising for at least the next two years, entering into a pre-letting agreement now has the added advantage of enabling a tenant to benefit from a lower commencing rental once construction of the selected building has been completed. The volume of vacant floor space reaching the open market via the development process is therefore being eroded as a consequence of pre-completion lettings which is limiting choice and underpinning rental growth. “The Walkie Talkie Building,” 20 Fenchurch Street (674,000 sq ft) and “The Cheesegrater”/Leadenhall Building (610,000 sq ft) were both over 50% let prior to completion.”

By Q1 2016, Carter Jonas forecasts that average rents for prime located, mid-rise, Grade A City and West End office space are anticipated to reach £65.00 per sq ft and £127.50 per sq ft respectively, and £75.00 per sq ft and £61.00 per sq ft in the Midtown and South Bank markets (see table 2).

Michael Pain concluded:  “The continuing imbalance between the supply and demand for office space throughout London is resulting in a shift in the balance of negotiating power away from tenants as rents rise and rent free periods get shorter. Some landlords are hardening their positions in lease negotiations by no longer offering break options, or break linked rent free periods and some landlords are demanding rent deposits where previously none would have been required.”

During the first half of 2015, the uncertainty surrounding the outcome of the General Election is likely to result in some dampening of office space demand. However, researchers at Carter Jonas believe that demand and rental growth will pick up during the second half of the year as businesses continue to expand and hire more staff, as the world economy continues to recover from recession.

Q1 2015 Central London Office Market Update – Key Findings

• Peripheral Central London office sub-markets have witnessed higher levels of rental growth compared to prime locations as they play “catch-up” – Grade A office rents in the east City fringe have risen the most - by up to 21% since Q1 2014, with the South Bank registering the second highest level of rental growth – up to 16.7%
• Rental growth in the east City fringe has been fuelled by stock shortages and increasing demand from tenants migrating from higher cost locations in the City core, Midtown and West End
• South Bank vacancy levels have fallen significantly over the last 24 months in the wake of large scale office lettings, principally to media companies including, for example, Omnicom which has recently taken 370,000 sq ft at Bankside 2 and 3 in Southwark
• Rents for Grade A space in prime West End office locations such as Mayfair have recorded more modest rates of growth over the last 12 months – between 2.4 – 4.2 % in contrast to neighbouring districts such as Victoria – where rents have risen by up to 14%
• It now costs up to £102.50 per sq ft pa in rent, rates and service charge costs to occupy Grade A office space in the prime City core - contrast with prime West End locations such as St James’s and Mayfair where total occupancy costs are up to 83 per cent higher – and are now as high as £187.50 per sq ft pa – this statistic explains the increasing trend for West End occupiers to migrate east
• The combination of supply side constraints and increasing demand from occupiers, as the economy emerges from recession, has resulted in several sub-markets recording their highest ever rents for new and comprehensively refurbished Grade A space, including:
• The City core – 2014 saw office rent records being repeatedly broken for the upper floors of tower buildings as The Walkie Talkie and Leadenhall Building vied for the honour of most expensive City building – at the time of writing that title is about to go to the Leadenhall Building, assuming that the proposed letting of the 41st floor (7,700 sq ft) to FM Global proceeds to completion – where a rent just shy of £85.00 per sq ft is reported to have been agreed
• East City fringe, E1 – recent lettings at Commodity Quay, St Katherine Docks are reported to have been agreed at rents of circa £60.00 per sq ft
• Hammersmith, W6 – the lettings of the last available floors at 10 Hammersmith Grove are reported to have been agreed at rents approaching £50.00 per sq ft
• Victoria, SW1 - Land Securities’ pre-completion letting of 56,000 sq ft to Jupiter Asset Management at The Zig Zag Building is understood to have been agreed at circa £80.00 per sq ft
• South Bank, SE1 – Arma Partners is reported to have agreed a rent of £80.00 per sq ft on the letting of 10,500 sq ft on the 27th floor of The Shard
• King’s Cross, N1 – recent lettings at 2 Pancras Square have set new rent benchmarks of over £75.00 per sq ft
• Mayfair – terms are understood to be close to being agreed on the upper floors of 30 Berkeley Square at a rent approaching £150 per sq ft

Michael Pain, Head of Carter Jonas’ Tenant Advisory Team commented: “The dominant theme for tenants during 2015 will be the search for better value. Rent sensitive tenants are being priced out of established central office locations by rising rental and business rates’ costs and are migrating to peripheral areas – this explains why we have seen rents in hitherto cheaper areas such as the east City fringe rise by up to 21% during the last 12 months. Even Docklands, the last sub-market to record rental growth post banking crisis, and where vacancy levels are appreciably higher than other sub-markets, has seen rents grow by up to 6% since the beginning of 2014.”

• Only three sub-markets now offer refurbished Grade A space at rents below £40.00 per sq ft pa – Docklands, east City fringe and Stratford
• Prime City core office rents are now £57.50 - £67.50 per sq ft pa – representing a rise of up to 13% since Q1 2014, and are typically £72.50 - £82.50 per sq ft for the upper floors of tower buildings
• Rents for mid-rise prime located Grade A office space in Midtown are £62.50 - £72.50 per sq ft, having risen 8.7% since the beginning of 2014, and £52.50 - £59.50 per sq ft on the South Bank – up to 16.7%
• West End office rents for new and refurbished prime located space are now typically £102.50 - £125 per sq ft pa and £65.00 - £80.00 per sq ft pa for space in secondary areas such as Victoria and Fitzrovia

Michael Pain added: “It is interesting to note that while supply and demand have conspired to tip the balance of negotiating power in favour of landlords, there has been a relatively modest compression in rent free periods throughout most of the London office sub-markets since Q1 2014 – reflecting the fact that landlords are keen to enhance the investment value of their property assets by maintaining high headline rents.”

Over the last few years, the north City fringe, Farringdon, Clerkenwell and Shoreditch has witnessed a substantial increase in rental growth and is rapidly becoming a “mature” market – rising from, typically, £28.00 - £37.50 per sq ft for refurbished air conditioned space at the beginning of 2010 to £46.50 - £57.50 per sq ft pa today – a rise of up to 66% over 5 years. Rents have been driven by an influx of media and creative businesses that have been priced out of areas such as Soho, Fitzrovia and Covent Garden and technology companies attracted by, hitherto, low rents, quirky buildings and the ability to network and exchange ideas at local cafes and pubs. However, some tenants are switching their property searches to the east City fringe which, for the time being, offers better value. This migratory trend is reflected in the contrasting rates of rental growth for new and comprehensively refurbished office space in the north and east City fringes – up to 15.5% and 21% respectively since Q1 2014.

Michael Pain concluded: “Crossrail, once operational in late 2018, should assist in relieving the upward pressure on office rents, particularly in the W1 postcode area, by improving accessibility and reducing travel times to other districts thus opening up a wider range of lower cost property options for tenants to consider. Canary Wharf, for example, where rents for refurbished Grade A space are typically between £35.00 and £40.00 per sq ft pa, will be just 13 minutes from Bond Street, via Crossrail, where rents for similar quality space are currently £79.50 - £97.50 per sq ft.”