While London has weathered an uncertain economy surprisingly well and looks set to remain stable in the upcoming year, occupancy rates are expected to fall with tenants having more of a choice in buildings and amenities than ever before. It is therefore vital for building owners to provide the connectivity and technology that sets your property apart from the others - so why aren't more companies doing this? 72% of building owners have listed funding constraints as the biggest challenge they face in implementing new technology, yet 41% of companies have said that they would look elsewhere if the solutions they needed were not readily available in a potential location*. Offering your tenants and guests world-class connectivity is the quickest and most effective way to distinguish your property from that of your competitors. While location and transport links used to be at the top of every tenants laundry list of must-haves, commercial agents are instead seeing an increase in companies willing to sacrifice location for state-of-the-art and connected smart buildings. Are you offering tenants what they're looking for?
End of year data for London offices emphasised the challenging nature of 2016, despite a positive uplift in transaction levels for Q4. Overall take-up rose by 10% q-on-q and was, in fact, up by 16% in comparison to Q4 2015. Regardless, annual take-up was down by close to 1 million sq ft y-on-y and 8% down on the 10-year average. Much of the uplift can be attributed to the letting of 542,000 sq ft at 10 South Colonnade, E14, to the Government Property Unit, although pre-letting activity continued with the standout deal to Barings, which signed for 113,000 sq ft at Land Securities' 20 Old Bailey, EC4.
Almost inevitably, vacancy rates have started to rise within the City and West End markets. Absorption has slowed markedly, but remains far removed from the depressed levels experienced the worst of the downturn. Grey space is beginning to filter onto the market, particularly in the City, with close to a million square feet currently being marketed. Nevertheless, vacancy rates still remain sub-trend and, coupled with supply levels that are still consistently below average, there is no prospect of oversupply in the short term.
Investment volumes have surprised to the upside with an end of year rally in demand for product. Chinese investors spent £14b in Q4 across nine separate deals with an average lot size of £158 million.
City of London
As in the West End market, the City, despite seeing absorption levels remain positive y-on-y (see Figure 1), has experienced a sharp decline in take-up. Annual transactions fell by 22% and were at their lowest level since 2003, 18% below the 15-year average.
The prospect of increased re-gearing of leases and landlords seeking to retain tenants during this continuing period of uncertainty is impacting on churn of stock and occupation levels. That said, Grade A vacancy still remains significantly below trend. Release of grey space is increasing, although current levels are within normal parameters. We expect approximately 1.5 million sq ft to be released by occupiers in 2017-2018. Encouragingly, Canary Wharf, which has been a significant source of 'grey space' in previous cycles, saw close to a million sq ft of surplus space absorbed during the course of 2016.
Despite post-referendum uncertainty, there remains a potential for supply shortages across specific City and Fringe submarkets, namely Southbank, Midtown, Farringdon, and EC4, over the next 12-36 months. It is likely that delivery of new product will be constrained, as developers and investors delay major schemes until greater clarity of EU exit timelines and likely impact, particularly upon the City of London.
We expect prime rents to come under further downward pressure over the next 12 months as the full impact of the UK's decision to exit the EU begins to become clearer. High street and investment banks have already been under pressure to cut overheads as the full impact of the sustained low interest rate environment hits profits. We anticipate modest rental reductions of between 2-4% in 2017 with headline rents remaining flat in 2018 before rising once more in 2019.
Annual West End take-up stuttered in 2016 falling to its lowest level since 2009. Total transactions ended 2016 over 25% on the 10-year average. Appetite from landlords to re-gear leases is impacting on churn of stock and transaction levels and we would expect this trend to intensify over the next 12 months as occupiers search for increased flexibility in lease negotiations.
In spite of significantly below average take-up, the West End saw a relatively modest rise in vacancy rate y-on-y, although the trend continues to be upwards, as deals take longer to complete and occupiers remain cautious. St. James's did see vacancy spike, as the completion of St. James's market added over 120,000 to availability. Further evidence of this trend is the fact that availability of new/refurbished space rose for the first time in over 12 months, however, speculative completions were at their highest quarterly level in four years. In contract, 2017 completions in core West End locations will be below trend.
Occupational deals activity has been dented by wider market uncertainty and occupier caution.
Demand levels are still stable, but protracted lease negotiations and lack of market churn have diluted absorption levels.
While vacancy levels have tracked upwards, market balance between supply and demand is on trend.
A number of submarkets will see a significant shortfall of new Grade A supply in 2017.
Overall rental growth will be negative in 2017 with headline falls of 3-6%.
Far Eastern money will continue to drive investment demand, with new players boosting volumes.
Institutions will continue to watch occupier markets and pricing closely, responding accordingly.
This blog is an excerpt from Colliers International London Offices Snapshot 2017.