Knight Frank's Q2 2010 central London quarterly office market research has just been released and current demand, supply and take-up figures make encouraging reading. So, will the key decision makers in the industry be lying comfortably on their sun loungers during the summer recess or will the prospect of ‘double dips’ or ‘triple tumbles’ be dwelling on their minds?
The Knight Frank Valuation team is often asked to crystal ball gaze and whilst we are unable to forecast where values will lie in the future, we are committed to providing focused opinions regarding future market conditions. It is a pre-requisite that these views are supported by the comprehensive data that our research team collates but, even more importantly, that they take into account the ‘coal face’ reactions from our capital and leasing market teams without which we would be unable to operate as effectively.
In summary, our research indicates that take-up across central London fell to 2.7 m sq ft in Q2 2010 reflecting a ‘pause for breath’ after two quarters of take-up well above the long term average. The City market recorded a marked fall in the volume of space transacted, although this is mainly attributable to a lack of large-unit deals seen in the first quarter. In our view, it is unlikely that the lower Q2 take-up figures signal any serious underlying problems in the market’s recovery, as a number of large unit deals are expected later in the year, particularly in the City. There is also evidence that the volume of space transacted in smaller units (sub-50,000 sq ft) in the second quarter matched the previous quarter’s healthy level, which indicates the continued strengthening of market fundamentals. In the West End, leasing activity remained relatively strong albeit lower than the previous quarters.
According to William Beardmore-Gray, head of Knight Frank’s City Leasing team “it is encouraging to see the geo-political upsets of April and May did not derail the market” but the Q2 figures do remind us that “recovery is still at an early stage”. We expect the market will gain a better understanding of where we are later this year, once all the dust from the Euro debt crisis settles and we find out how well the pipeline stacks up against demand. Despite this, Beardmore-Gray pointed out that “an occupier in the City, seeking 200,000 sq ft of new build space, can count his options on one hand”. Equally, in the West End, whilst demand has yet to see an uptick, “there are only two new schemes to complete in the Core during the next 18 months”.
In fact, availability in Central London fell for the third consecutive quarter and now totals 20.1 m sq ft, an 18% fall from the cycle’s peak of 24.6 m sq ft in Q3 2009. Whilst the availability of second-hand accommodation remains relatively stable as tenants who have taken new space have released their old offices to the market, the supply of new and refurbished space has continued to fall due to the decline in speculative development activity. We are now witnessing developers with sufficient funds moving to take advantage of the potential shortfall of supply and we expect a number of significant schemes to commence on site during the coming six months. As Bradley Baker, head of Knight Frank’s Central London tenant representation suggested, for an occupier “it is a balance between making a property decision now when his own business outlook is uncertain, or waiting for calmer times knowing the office market is edging further into the landlord’s favour”.
So how has this translated to the investment market in recent months? Central London investment turnover rose considerably during Q2 to £2.9 billion. This increase of 70% during the previous quarter’s level was partly attributable to an unusually high number of £100 million plus sales that completed across the market. Growing confidence in the occupational market has prompted an increase in demand from domestic institutional investors, although overseas purchasers remain dominant, accounting for more than 70% of transactions. Ker Gilchrist, head of Knight Frank’s West End investment team, confirmed that “foreign buyer interest remains high. It stretches from sovereign wealth funds making large long-term investments, to private individuals looking for a safe haven from the Euro crisis”. There is also strong demand for assets in the right location with short-term income which, as he sees it “can be brought through the development pipeline to take advantage of the strong market conditions expected in 2013 and 2014”. These types of assets remain scarce and competition is fierce and this is contributing to prime yields continuing to tighten in both the City and West End, with pricing almost at the same level as the peak of the market in 2007.
In summary, our view is that the market is a little more nervous than it was three months ago following the recent political and economic uncertainty. However, the emerging big picture regarding central London offices, is that a shrinking development pipeline is going to squeeze supply next year and this is most likely going to result in further rising of rents. We maintain that prime yields will remain under pressure while demand remains strong and interest rates remain at their current level. So perhaps, instead of ‘double dips’ or ‘triple tumbles’, for the central London market at least, those returning from holiday can expect a ‘hop, skip and a jump’?
Robert Gray
Partner, UK Valuations
Knight Frank LLP
020 7861 1290
