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London has demonstrated once again the effect it has on the office market as a result of being one of the world’s major business centres.

For example, financial services company Bloomberg recently committed itself to moving to a new 500,000 sq ft building in the City of London, although the space will not be ready to occupy until 2015.  This is not a one off instance – a significant number of large lettings occurred in the 2^ndhalf of 2010 in both the City and West End.

That is because improving economic conditions at the end of last year have translated into a significant turnaround in the Central London Office market with supply falling and rents rising.

At the end of 2009, the vacancy rate across Central London was 10.2%.  As a rule of thumb, a vacancy rate of over 10% results in rents falling and incentive packages increasing in value.  When that rate is under 10%, rents tend to plateau.  Then rents  rise again as the vacancy rate falls towards 7.5%. Incentives shrink in value at the same time.

Twelve months on, the vacancy rate is down to 8.6% following a 20% fall in the available stock.  The result has been an increase in headline rents for best space (2009 rents).

            West End        £82.50 per sq ft (£65.00 per sq ft)

            City                  £52.50 per sq ft (£44.00 per sq ft)

So what was the financial impact?

Let’s assume a business could have chosen to acquire a new 10,000 sq ft office on a 10 year lease in the West End a year ago, but for one reason or another delayed until today.  So what?  Well, the headline rent would have increased AND the incentive package will have shrunk.  The combination of these two forces would have meant that the financial impact would have translated into a 35% increase in rental costs over the life of the lease.  For a business seeking an office in the City, the increase in cost would have been around 27%.

Not only has the cost of new space increased but even an “average” property will have seen rents increase by maybe £2-3 per sqft, accompanied by much lower incentives.  However, the change is not as significant as for new or refurbished space.  This is where the focus of the demand has been for the last four quarters. 

The perceptions, and indeed the reality was that space was about as cheap as it was going to be, so those occupiers who could trade up, did so, thus fuelling healthy demand of the better quality space.

Also, as the economic conditions improved it was noticeable that many office occupiers withdrew their surplus space from the market, thereby accelerating the fall in supply.

What are the trends for 2011?

With a limited number of buildings under construction, rents will continue to be pushed upwards, incentives will fall and leases will get tighter. However, there are a number of headwinds facing the London office market. 

• The Comprehensive Spending Review – the Government and associated public bodies are largely located in Westminster, where they occupy around 18% of the stock.  It is unlikely that space will be released wholesale.  However as space must come to the market, the balance of demand v supply may well be affected.
• An Uncertain Economic Environment – the impact of the spending cuts and the VAT increase on Central London’s economy has yet to be seen.  Business confidence in Q1 2011 will play a key part in deciding if relocation and expansion plans are implemented, or not.
• Slowdown in Take Up – many recent property acquisitions are the result of searches that were initiated 2-3 years ago.  It is our expectation that occupiers will think hard about their space needs and will look to consider solutions such as new ways of working before committing to cash intensive relocation projects.

On balance though we see supply continuing to tighten, especially with the better space.  Simplistically, as we stated above, this means that rents will rise and incentives will decrease.

So how can you exploit the trends?

Looking forward, from today and into next year, there are some interesting opportunities for the well organised occupier.  Here a few ideas:-

• Landlord Confidence – this is steadily increasing so you can expect to see an a greater propensity to consider lease surrenders provided the space can be upgraded and let on a higher rent.  However, beware those bearing gifts!  It is critical you do not give away a good negotiating position away!
• Know Your Landlord – occupiers with surplus space are generally very positive about reducing their overheads, sometimes overly so.  Last year many landlords either supported this strategy or turned a blind eye as they were keen to keep their primary tenant.  This “sympathetic” attitude is likely to change as the markets harden.  Landlords will start to be more assertive about ensuring their tenants do not undermine their asset values by sub-letting space at give away rents.  So under-lettings at below market terms will become harder. However if you plan properly, record your marketing initiatives in the right way and develop a good working relationship with your landlord (and his advisor) then there is a much stronger chance any proposal you make will be passed through and quickly.
• Short Term Leases – if a lease has less than 3 years to run, typically the demand is not so great.  The rationale being that occupiers tend to want slightly longer terms of between 3 and 5 years for all sorts of reasons – operational and financial.  However, if you are looking for space and can be flexible on the lease term, then you might well find a real bargain.
• Lease Expiries and Breaks – even though the market is improving in favour of the landlord, property companies do not want to lose their tenants.  Provided you play your cards carefully and sensibly AND in good time, lease expiries and / or lease breaks still remain potentially fabulous opportunities with which to leverage your power as a “paying customer”.
• Maintain Regular Contact - it is also noticeable that numerous landlords and managing agents are leveraging the provisions in their leases to use service charges to maintain their buildings to the highest standards.  This is a two way street.  If as an occupier you are proactive and apply what we call a ‘Landlord Liaison Programme’ you will always be ahead of the curve and, our experience confirms that in most cases you will even be able to influence the shape of the curve!
• Impose a Constant Watch – inflation is here.  Virtually every line item on the service charge and running cost agenda will rise.  However, if you keep a constant watch on your management data and ensure these are mapped back to other costs and your revenues (on an automated basis) you will see the trends emerging.

In conclusion?

The Central London office market has survived the downturn.  In part, this is due to the huge international influence of the financial markets, but it is also due to the lack of oversupply and the pragmatism of landlords in reducing rents for their tenants. 

Looking forwards 12-24 months, occupiers can expect to experience a hardening in the markets such that landlords with good buildings, in good locations will be able to command much improved terms.  Indeed this is already happening.

The key factor for success for the average occupier is through greater regularity and care of by which the right data is monitored and far more effective planning.

As experts we see far too many examples of occupiers failing to understand that the property market works in a different way and by different rules.  As a result late decisions lose value and poor decisions undermine corporate value and haemorrhage cash.

A final thought – whilst really good advice is not free, it should never be regarded as a cost!

 

Haywards is a leading commercial property and workplace advisor representing the needs of occupiers throughout the UK and across Europe.  We deliver our clients sustained business profitability and flexibility by increasing the contribution made by their property and workplace environments.

If you would like to know more please do not hesitate to call Iain Rackley on 020 7101 0200

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