During the second quarter, three key defining themes emerged in London’s office market and we explore these below. 

1. Supply still weak

We’ve been reporting for some time on how a shortage of supply is driving occupiers to begin exploring options well in advance of lease expiries. At present, this is happening on average up to two years before the end of a 10-year lease, up from roughly 18 months historically.

This is particularly prevalent for space in excess of 20,000 sq ft, where competition is intense. To put this into perspective, we are tracking 26 requirements for over 100,000 sq ft, however there are just 14 schemes that can accommodate a requirement of this size; none are in the West End.

Nevertheless, what this also means is that occupiers are remaining on the demand schedule for longer, suggesting requirements may be somewhat weaker than the headline numbers indicate.

Separately, the lack of options in the market means geographic loyalty is limited, with occupiers looking for West End options often drifting towards the City, driven by both cost and the availability of space.

Those that are determined to secure space in a particular location are willing to pay a premium in order to do so, such as the record breaking £250 per sq ft lease agreed at 30 Berkeley Square by an Asian hedge fund at the end of April. There are a growing number of such “super prime” deals and this is a theme we are monitoring closely.

Furthermore, prelets are continuing apace, with no discounts being offered, underscoring the challenge faced by occupiers. The bottom line is that there is a demand-supply mismatch. Employment levels are at a historic high and this is translating into requirement levels that far outstrip the available stock. As a result, 50% of the development pipeline has already been prelet, with matters in the West End even more severe, where 68% of all space under construction is prelet.

Supply currently stands at 12.7 million sq ft, 9% below the 14 million sq ft recorded by the end of the first quarter and 21% below the long-term average.

2. Flexibility is key

In contrast to the market for larger space, there is a growing volume of space available in the 2-5,000 sq ft bracket, which accounts for 26% of all stock. The sub 5,000 sq ft market itself accounts for about 37% of all floor plates in London, rising to 42% in the West End. Vacancy rates for this segment of the market are in the region of 10%.

The rise of flexible office space, which is able to provide plug and play solutions, with flexible lease terms, often at initial prices that are more competitive than traditional space of this size, means that landlords are having to innovate. They are being driven to offer their own version of flexible space in order to stay relevant.

"The sub 5,000 sq ft market accounts for about 37% of all floor plates in London"

Some larger landlords already offer break clauses at year five, on 10-year leases, with many others following suit. There is a small, but notable rise in concerns amongst landlords of a potential change in government and so some are pre-emptively attempting to make their assets work harder in the event of a Labour government.

Bridging the gap between the requirements of start-up businesses and large corporates is emerging as an area that many landlords can service effectively, which is in turn driving demand for fully managed solutions amongst this cohort of occupiers.

Structural market changes are often identified in hindsight; however given the way in which the market and occupiers are responding to the flex phenomenon, it’s clear that we are indeed in the midst of such a shift. Our (Y)our Space report has identified the flex and core concept as being an emerging trend, whereby businesses will, in future, frequently have a need for both fixed core offices and space they can ‘flex’ in and out of.

3. UK institutions poised for return

International investors routinely account for 70-80%+ of total office investment activity in London. However, with some overseas investors paring back activity, we have noted an upturn in interest from UK institutions in the London office market. Some now sense an opportunity to acquire assets in a less competitive field. In addition, signs of a wider global economic slowdown may also be boosting the attractiveness of London.

The fact remains that there is a growing pile of capital waiting in the wings, both domestic and cross border; however the deployment of said funds does appear, at least in part, to be hinged on the resolution of all things Brexit.

In addition, currency related discounts, relative to the period before the decision to leave the EU was taken, make London office assets cheaper than their counterparts in cities like New York, or Hong Kong. Despite this however, the rate of capital deployment is expected to remain subdued in the short term, especially amongst the international cohort.

This slowdown also echoes what we are recording across Europe as a whole as well, with investment volumes on the continent dipping by 12% to £30.8 billion when comparing H1 2018 and H1 2019 (RCA).