Office sector: tale of two cities

The latest data paints a mixed picture of the London office market. Prime office rents in the City are down 1.5% from last year, while in the West End rents are down 6.4%. 1


But according to property specialists Cushman & Wakefield, “Central London saw 2.65 million sq ft of lettings, 6% ahead of the five-year Q1 average.” Savills’s data concurs: “Strong demand has carried through into 2018 with a total of 478,644 sq ft going under offer in January. This brings the total volume of space under offer to 1.4m sq ft, 10% up on the long-term average.”


Long-term rise in volume of London office space under offer
Fall in office construction in the last 6 months of 2017, compared witht he first half of the year

And CBRE’s monthly snapshot (in February) indicates that central London office total returns were 0.6% while capital value growth was 0.3%. So it is no surprise that we are also seeing strong demand among our clients for finance both for properties in the City and beyond. But there are other factors to consider.


Brexit and economic uncertainty has taken a chunk out of new starts and this might adversely affect the supply side of the equation. Deloitte’s London Office Crane Survey at the end of last year found that office construction was down 9% over the last six months of 2017 and the survey recorded the lowest volume of new space started since 2014. (Note that completions last year were actually at a 13 year high.)


Yet demand remains strong for a variety of reasons (see below). In the City, in particular, we’re seeing evidence of shorter rent-free periods, fewer voids and more interest pre-completion.


Crossrail: east meets west

One of the biggest drivers of activity has been anticipation surrounding Crossrail – now christened the Elizabeth Line. Europe’s biggest construction project of the past decade is almost complete. We’ve seen office developments fully integrated into the new stations too, strengthening their attractiveness.


When the Elizabeth Line goes live, an extra 1.5 million people will live within 45 minutes of the West End, the City and Canary Wharf – up from five million currently. For investors seeking new developments with plenty of growth potential, there is a strong buying opportunity.


The Elizabeth Line has certainly been a driving force behind interest in Clerkenwell, for example, where the major new station at Farringdon will ease access to central London, Docklands and across the west of the city. But I think people miss the point on this - the real reason people are drawn to areas like Clerkenwell is the impressive fit-outs and targeted marketing for tenants that appreciates the changes in how we work. 


Tenants: New kids on the block

It is impossible to invest intelligently in commercial property without understanding wider changes in work and social habits. We have been structuring finance solutions in property for a long time and we are alive to the kinds of cyclical issues that affected developers, landlords and tenants in the last downturn.


Changes to office use and tenant requirements are also critical to understanding the investment potential in the office market. As we have seen, a typical office in Clerkenwell might see new floor space taken by a modern furniture showroom, a film production company and a fintech start-up. That more diverse mix is increasingly common and very attractive in terms of managing income risk.


One huge trend we have long been monitoring is the growth in flexible and serviced workplaces. Cushman & Wakefield reckons flexible workplace operators currently occupy around 10.7 million sq ft of space in Central London – roughly 4% of the total stock.


Many landlords recognise that modern workplace environments are a huge boon to tenant recruitment.

Deloitte’s 2017 survey claims co-working operators occupy more office space than traditional sectors such as professional, legal and even technology, media and telecoms (TMT). A great example is the LabTech Group’s development of a 140,000 sq ft mixed-use scheme in King’s Cross. Investec arranged £72m of funding to support the development, which will include residential and co-working spaces to meet the needs of a much more agile tenant base.


Even corporate tenants want more collaborative floor space, different types of work areas and configurations. Many landlords recognise that modern workplace environments are a huge boon to tenant recruitment.


They extend beyond simple fit-outs to include more varied and often smaller floorplates to widen the net for potential occupiers. It is also smart risk management. While bigger floorplates remain valuable when let, any turn in market sentiment could leave owners with hard-to-let space.


We recently looked to help finance a property in the City offering floorplates of between 1,100 and 1,200 sq ft – small by historic standards. But the interest was overwhelming. Three of the six new tenants had outgrown their serviced shared offices, and were looking for 1,000 sq ft plates in up-and-coming areas.


However there is always risk, and while it might seem tempting to rush at deals and deploy capital, we remain firmly convinced that market intelligence, strong knowledge of new developments (and their fit-outs) and likely demand are key to making smarter investment choices.


GB and EU flags
Despite being in the "wait and see phase" of Brexit, quality assets are still coming on to the market
Brexit: the great unknown

This diversification of use, more flexible floorplates and general infrastructure improvements should go a long way to offsetting broader macroeconomic risks. While the experts – both in government and beyond – are still unclear what the UK’s relationship with the EU will look like once we leave, Brexit will affect work in London and the calculations on smart office investing.


We don’t underestimate the complexity of the task of exiting the EU, or the potential effects as the broader cycle of the economy plays out. However, we do believe some things will not change. London might lose some occupiers to other markets – there’s a strong argument for Dublin to benefit, for example, and other European cities have made high-profile plays for London’s fintechs – others will come in their place.


Conversations with colleagues outside Europe are revealing in terms of London’s continued standing as a business and financial centre. Take fintech: any start-up or scale-up business needs to be at the heart of this vibrant sector. New York and Berlin are attractive, but the conversations we have been having show that for innovation and energy in that sector, London remains the big draw. Hence Old Street, Shoreditch and beyond retain strong investment potential.


And while we remain in the "wait and see phase" of Brexit and the economy more generally, we continue to see quality assets come on to the market, which is a positive.


As a result of [Brexit] caution, those bringing assets to market expect a premium, especially from international investors.

One interesting factor is that many owners of office property remain reluctant to sell. That may stem from a range of concerns, such as toppy multiples and low yields in other asset classes, for example. But uncertainty over how to invest proceeds is surely playing a role. Simply put, these owners are made cautious by Brexit and general uncertainty in the markets.


As a result of that caution, those bringing assets to market expect a premium, especially from international investors. And there are a lot of investors keen to buy these assets once they can get the right finance package in place. Competition can be fierce for the premium office properties, so having knowledgeable and fast-acting finance partners is an essential edge for those buyers.


A client-led approach

The upshot is that a focus on quality and solid intelligence remain key differentiators which is why our approach to structured property finance has stayed the same. We are client-led, believing that by meeting our clients’ needs swiftly and expertly, we will continue to lead the industry.


Through our network of lawyers, valuers and surveyors, we are able to react swiftly to any opportunity that appears and design the right financing structure to get the deal done.


We also play the long game. We know that for most investors, closing the deal is just the start. We anticipate clients’ financing requirements across the life of their investment, bringing them much-needed flexibility, especially during less-certain times.


Whatever the outcome of Brexit negotiations, new business models, changing infrastructure or economic cycles, Investec is always proactive, client-led and scalable. 


Cushman & Wakefield, UK Office Market Snapshot, First Quarter 2018