OFFICE MARKET OUTLOOKLondon, January 2018

Rent corrections gather momentum in many locationsDuring the final quarter of 2017, 10 of the 18 Central London office submarkets we monitor registered rent falls, with momentum building on the corrections that began during Q3. With additional incentives such as contributions to fit out costs and even delayed completions becoming commonplace in many locations, net effective rents continued declining during the final three months of 2017. This translates into 18 months of faltering net effective rents, since the Brexit referendum.

In order to entice demand, some landlords have even begun to offer psychological rent reductions of as little as £2.50 psf to differentiate their buildings.

West End locations like Noho/Soho/Covent Garden and Paddington have been more resilient, with rents holding steady, underpinned by low vacancy rates (circa. 4%, CoStar), limited development pipelines and proximity to the Elizabeth Line (Crossrail).

cluttons.com

Q4 2017 Central London vacancy rate

Source: PropertyDataSource: CoStar

5.7% £3.12 billionQ4 2017 Central London office investment activity

-10.5%

Canary Wharf£42.50 psf

-9.1%

Hammersmith£50 psf

-8.3%

Mayfair£110 psf

-8.3%

St. James’s£110 psf

Good value to be had in some locationsCanary Wharf has become “a bargain location”, where occupiers are almost certain of securing a good deal. For instance, some space is available from as little as £37.50 psf, accompanied by a 30-month rent free period on a 10-year lease; something that is unmatched in many other Central London locations.

Biggest rent corrections during Q4 2017

Source: Cluttons

Performance of rents in Central London

Nearby South Quay (£35 psf), remains Central London’s most affordable location for prospective occupiers.

“Flexible” statistics distorting market healthQ4 2017 headline take up figures of circa. 3 million sq ft and a vacancy rate of 5.7% may appear healthy on the surface, with over 500,000 sq ft of pre-lets agreed, but there is increasing concern over the portion of this space that will be returned to the market via the ever-buoyant serviced office sector.

Whilst large deals, like the WeWork pre-let of 186,000 sq ft at The Stage in EC2, are positive for statistics, the rental reductions being recorded suggest that actual demand remains relatively subdued. To create an accurate picture of the take up, the availability of desk space within these serviced offices should be factored into overall vacancy as many of the larger serviced offices can take up to 12 months to be fully occupied.

Indeed, there is some concern about the potential for an oversupply of serviced offices. The Instant Group, for instance, reported that the amount of serviced office space in London grew 20% last year. Our own experience is that many larger corporate occupiers are still seeking conventional lease lengths for their core space, however they do require an element of flexible space to facilitate future expansion.

On the other hand, businesses leasing space under 5,000 sq ft continue to demand lease flexibility within the first five years, which has driven vacancy rates in buildings under 25,000 sq ft to their highest level in 25 years, according to CoStar.

Investment volumes remain steadyDuring 2017, purchasing activity in London’s office investment market was up almost 45% on 2016, rising to just over £14 billion, but this was down to a handful of very large deals.

Total Returns for All Property in the 12 months to the end of December stood at 11%, according to IPD/MSCI (Monthly Index), compared to about 7% to 8% for equities, so property still looks more attractive than other asset classes, including Gilts.

Looking at Q4 2017 specifically, total investment volumes into Central London offices held steady at £3.12 billion, marginally lower on Q3 2017 (£3.15 billion), according to Property Data. Overseas investors continued to dominate deals, accounting for

almost 90% of all transactional activity. And with many of these purchases not requiring any onshore debt financing, the volume of commercial property lending in the UK fell by 24% during the first half of 2017 (De Montfort Commercial Property Lending Report).

Investors from the Far East remained the most active, committing to £1.3 billion worth of London office purchases. This group was closely followed by investors from the US (£868 million) and the Middle East (£380 million).

While the total number of deals remains limited, the magnitude of capital entering the market is supporting relatively stable capital values, although these too have begun to weaken in many locations.

In contrast, UK investors have preferred to invest in the regions instead of London, in search of higher income returns. Domestic investors remain cautious and risk averse, with pension funds for example, preferring inflation proofed assets. At 4% capital growth and 7.5% total returns in the 12 months to December 2017, Central London Offices have underperformed the All Property IPD/MSCI Monthly Index and this trend is likely to continue.

2018 outlookDespite this and although there is a perception that Central London offices are currently fully priced, possibly over priced, by both occupiers and domestic investors, London remains a resilient city, continuing to attract high volumes of overseas capital. Employment growth is of course expected to be influenced by both the levels of GDP growth during 2018 and the Brexit divorce proceedings, which in turn will affect rental values. That said, to date there is no evidence from recruitment agencies to suggest a current, or planned exodus of finance and banking professionals from the City.

We expect London’s office market to continue to evolve and adapt, with increased levels of flexible working for instance, likely to fuel demand for shorter leases. Furthermore, the opening of the Elizabeth Line (Crossrail) later this year will undoubtedly benefit markets directly in its path, as the positive impact of this major infrastructure improvement filters through.

Assuming these current market trends continue, it is our view that rents and capital values are likely to continue softening during 2018. Our view is that capital values may decline by 3% to 5% on average, over the next 12 months.

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West End Midtown The City HammersmithSouth Bank Docklands

Source: Cluttons

Cluttons London office market outlook, January 2018

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Market Submarket Prime headline

rent* (£ psf)

Q/Q % change

12 month % change

Prime capital values (£ psf)

Q/Q % change

12 month % change

Hammersmith 1. Hammersmith 50 -9.1% -13.0% 840 -5.1% -6.7%

West End 2. Kensington & Chelsea 72.5 -6.5% -6.5% 1190 -6.7% -6.7%

3. Paddington 60 0.0% 9.1% 1030 -1.9% 7.3%

4. Marylebone 85 -5.6% -5.6% 1690 -3.4% -4.8%

5. Mayfair 110 -8.3% -8.3% 2500 -9.1% -9.1%

6. Noho, Soho & Covent Garden 85 0.0% 0.0% 1590 -3.6% -3.6%

7. St James’s 110 -8.3% -12.0% 2500 -7.4% -0.1%

8. Victoria, Westminster, Knightsbridge & Belgravia 75 -6.3% -9.1% 1300 -6.5% -7.1%

Midtown 9. King’s Cross 75 0.0% -3.2% 1230 -1.2% 2.5%

10. Midtown 65 0.0% -7.1% 1150 -1.7% 0.0%

Southbank 11. Southbank 65 0.0% 0.0% 870 -0.6% 2.4%

12. Vauxhall & Nine Elms 52.5 -4.5% -8.7% 690 -4.8% -8.0%

City 13. Clerkenwell & Farringdon 65 0.0% 0.0% 1060 -0.5% -3.6%

14. Old Street & Shoreditch 55 0.0% 0.0% 950 -1.0% -9.5%

15. City Core 65 -3.7% -7.1% 1250 -2.7% -2.0%

16. Eastern City Fringe 52.5 -4.5% -4.5% 820 -3.5% -3.5%

Docklands 17. Canary Wharf 42.5 -10.5% -10.5% 690 -9.2% -11.0%

18. South Quay 35 0.0% 0.0% 500 0.0% 0.0%

Central London office rental market heat map (Q4 2017)

£100+

£90-99

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Rent psf

*Rents quoted are headline, not net effectivePrime rents are defined as the top quartile of headline rents: excluding penthouses and floors with large terraces, as well as suites in large, iconic towers.

Key investment deals

Devonshire SquareWeWork (acquisition)

626, 135 sq ft(£580 million)

15 Canada Square, E14Kingsboard (acquisition)

434, 261 sq ft(£400 million; 4.25% net initial yield)

200 Aldersgate, EC1Samsung (acquisition)

434, 005 sq ft(£320 million; 4.5% net initial yield)

240 Blackfriars RoadWolfe Asset Management Ltd. (Al Gurg Family) (acquisition)

226, 271 sq ft(£266.5 million; £1,176 psf; 3.94% net initial yield)

Mitre House, EC1Union Investment (acquisition)

201,000 sq ft(£220 million; 4.5% net initial yield)

Source: Cluttons, EGi, CoStar

Key lettings

The Stage, EC2WeWork (pre-let)

186,000 sq ft

Ford Motors Warehouse, W6WeWork (letting)

45,000 sq ft(£39.50 psf)

5 Churchill Place, E14BCG Partners (letting)

100,000 sq ft

80 Charlotte Street, W1Boston Consulting Group (pre-let)

123,500 sq ft (£85.82 psf)

Source: Cluttons, EGi, CoStar

Source: Cluttons

Cluttons London office market outlook, January 2018

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For further details contactFaisal DurraniHead of research+44 (0) 20 7647 7166faisal.durrani@cluttons.com

Freddie Pritchard-SmithHead of commercial agency +44 (0) 20 7647 7094 freddie.pritchardsmith@cluttons.com

Ralph PearsonPartner – Commercial office agency+44 (0) 20 7647 7037ralph.pearson@cluttons.com

John Barrett Head of UK valuations +44 (0)20 7647 7218john.barrett@cluttons.com

Richard MossCity and West End of London Valuations +44 (0) 20 7647 7226 richard.moss@cluttons.com

Jamie McCombe Head of fund management +44 (0) 20 7647 7234 jamie.mccombe@cluttonscp.com