OFFICE MARKET OUTLOOKLondon, Spring 2018

OCCUPIER MARKET

Headline Rents Continue to Ease In the three months to the end of March 2018, headline rents have stayed largely flat, with the exception of modest falls into two of the 18 central London submarkets we monitor.

This is supported by the latest IPD/MSCI results which shows a marginal 40 bps increase on average in Central London for the same period and an annualised rise of 80 bps.

cluttons.com

Q1 2018 Central London vacancy rate*

Source: PropertyDataSource: CoStar

5.9% £2.35 bn

Q1 2018 Central London office investment activity

These results are somewhat out of kilter with the clear market evidence which suggests nominal declines in headline asking rates in some locations, but with the notable exception of a handful of best in class developments which continue to attract strong interest and high rents ahead of completion of works.

We are also aware that rent free periods are continuing to move out and in many sub sectors two years rent free is now readily available on 10 year leases. This indicates that net effective rents are still falling, once the incentives are factored in.

*Long run average is 7.9%

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Vacancy rates remain low The Central London office market continues to be underpin by a comparatively low vacancy rate – currently standing at 5.9%, well below the 15 year average of just under 8%, which is more or less the same following Brexit in mid 2016.

Central London office rents

Q2

2008

Q4

2008

Q2

2009

Q4

2009

Q2

2010

Q4

2010

Q2

2011

Q4

2011

Q2

2012

Q4

2012

Q2

2013

Q4

2013

Q2

2014

Q4

2014

Q2

2015

Q4

2015

Q2

2016

Q4

2016

Q2

2017

Q4

2017

Q2

2018

£100

£90

£80

£70

£60

£50

£40

£30

£20

Rent

psf

West End Midtown The City HammersmithSouth Bank Docklands

Source: Cluttons

In comparison, following the peak of the last cycle at the end of 2007, the overall vacancy rate in Central London moved out from 7% to an average of 8.2% in the following two years.

Cluttons London office market outlook, Spring 2018

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Vacancy rate for Central London offices

Source: CoStar

7.90%Q4 2008

9.20%Q4 2009

7.50%Q4 2010

7.20%Q4 2011

7.50%Q4 2012

7.90%Q4 2013

7%Q4 2014 6.20%

Q4 2015

6.40%Q4 2016 6.20%

Q4 20175.90%Q1 2018

Cluttons London office market outlook, Spring 2018

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Buoyancy in pre-letting activity Demand for best in class schemes is reflected in the comparatively high proportion of space in Q1 that was pre-let at just over 16% of total take up – this is materially higher than proportions seen in recent years at sub 10% of total stock.

Another feature of the pre-letting market which is at odds with the general trend, is for longer leases without breaks or a shorter frequency of breaks, although in many cases, this involves proportionately longer rent free periods.

Flat market outlookThe economic backdrop suggests the market is unlikely to experience much change over the course of the year, particularly as GDP growth for 2018 expected to mirror last year’s performance, thereby curbing the appetite for widespread expansionary activity by businesses. A telling factor is that take up in Q1 was circa. 50% down on the average quarterly take up during 2017.

It should be noted, however, that the 2017 take up figures which exceeded 2016 and were in line with 2015, have been heavily buoyed by major prelets in the City that reflected the culmination of three to five year projects, together with WeWork’s rapid expansion which accounted for 9% of total take up last year, including prelets.

Notwithstanding the latest poor take up figures, there are some signs that many occupiers who have been sitting on their hands since Brexit are treating the current economic position as the “new norm” and taking positive steps to plan their accommodation strategy around this.

Whether take up figures improve for subsequent quarters will very much determine whether the market holds or slides further with little to no prospect of average rents increasing for at least the next few years.

Landlords have been generally far more responsive to the recent downturn, than in previous cycles. This is not only in relation to rent and rent free periods, but also lease flexibility, together with a willingness to cap service charges and dilapidations with older style buildings. This has come at a time when market disruptions such as coworking and flexible working are forcing the flexible space agenda.

While this is in part a function of landlords being more in tune with occupiers needs, comparatively few landlords have their hands tied by high company debt ratios, in contrast to previous market cycles and hence, many are resistant to lowering quoting rents too significantly.

Repositioning people at the heart of building design is also something many landlords are rapidly coming to terms with. Many older buildings will need to be stripped of their ‘corporate feel’ and previously softer considerations around wellness and connectivity brought to the forefront if buildings are to avoid long term obsolescence.

With this in mind, it is unsurprising that smaller office suites under 2,000-3,000 sq ft are facing significant downward pressure on rents and as a result, some landlords are now investigating the provision of serviced office suites, which are increasingly in vogue.

Central London take up activity

Q1

2008

Q3

2008

Q1

2009

Q3

2009

Q1

2010

Q3

2010

Q1

2011

Q3

2011

Q1

2012

Q3

2012

Q1

2013

Q3

2013

Q1

2014

Q3

2014

Q1

2015

Q3

2015

Q1

2016

Q3

2016

Q1

2017

Q3

2017

Q1

2018

5,000,000

4,500,000

4,000,000

3,500,000

3,000,000

2,500,000

2,000,000

1,500,000

1,000,000

500,000

0

Take

up

(sq

ft)

Source: CoStar

Total take up Prelets

Long run avg: 3.59 million sq ft per quarter

Cluttons London office market outlook, Spring 2018

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INVESTMENT MARKETIn many ways, this stagnant, but arguably stable economic picture is aiding in the emergence of a relatively steady performance of both rents and capital values in London’s office market. This in turn is likely to continue fuelling the appeal of an acquisition, especially as commercial property continues to outperform equities, gilts and shares.

Investment volumes easeWhilst total investment into Central London offices during 2017 rose by 43.8% to £14.7 billion, driven by strong overseas activity, particularly from Asia, the Middle East and the USA, this spike in activity has been attributed to pent up demand from when investors moved into a holding pattern following the Brexit referendum. During Q1 2018 just £2.35 billion worth of office transactions in Central London have been recorded, which is down 37.1% on Q4 2017 and 46.7% down on Q1 2017; however, this level of investment is in line with the 18 year quarterly average for all Central London office investment levels of £2.78 million.

Still, in the 12 months to the end of March 2018, Central London offices accounted for the highest proportion of all commercial property investment in the UK, totalling 22.8% of deals by value (Property Data).

UK institutions still inactive in Central LondonUK institutions continue to remain relatively inactive in the Central London market, with just £88 million worth of office deals being attributed to this group in Q1, compared to transactions totalling £352 million in Q4 2017 (Property Data).

UK institutions have switched their focus to the regions, seeking out investments that offer long term income returns, anchored by strong covenants, preferably with built in inflation kickers. Industrial assets remain in high demand, although with a lack of stock in the wider UK market, investment volumes in the sector have waned, falling to £12.5 billion in Q1 2018, from £18.1 billion in the last quarter (Property Data). The industrial sector in general remains the most attractive, with IPD/MSCI showing total returns of 22.2% in the 12 months to the end of March 2018, significantly higher than Central London offices (7%).

Total returns seen easing in 2018For now, our expectation is that All Property total returns are likely to ease this year from 11.3% in the 12 months to the end of Q1 2018 (IPD/MSCI) to around 6.5% to 7% by the end of the year, continuing to outperform gilts and equities. Central London offices, in contrast, will likely see total returns retreating from 7% at present to 3.5% to 4.5% as capital values and rental values will both likely continue to register nominal declines through the course of the year as we work our way through the bottom of the current property cycle.

Despite this however, the voracious overseas appetite for the capital’s trophy office buildings is not expected to wane, although this may have more to do with fluctuations in the strength of purchasers’ currencies, rather than the performance expectations of the property being acquired.

Total Returns for commercial property still attractive

Mar

15

Apr

15

May

15

Jun

15

Jul 1

5

Aug

15

Sep

15

Oct

15

Nov

15

Dec

15

Jan

16

Feb

16

Mar

16

Apr

16

May

16

Jun

16

Jul 1

6

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17

Feb

17

Mar

17

Apr

17

May

17

Jun

17

Jul 1

7

Aug

17

Sep

17

Oct

17

Nov

17

Dec

17

Jan

18

Feb

18

Mar

18

30%

25%

20%

15%

10%

5%

0%

-5%

-10%

Standard Office All Retail Standard Industrial All Property Types Offices – Central London Gilts FTSE All Share Base rate

Source: IPD/MSCI, FTSE, FT

Cluttons London office market outlook, Spring 2018

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“UK institutions continue to remain relatively inactive in the Central London market, with just £88 million worth of office deals being attributed to this group in Q1 2018.”

Cluttons London office market outlook, Spring 2018

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GREENPARK

HYDE PARK

BATTERSEA PARK

1 2

3 4

65

7

8

9

10

11

12

13 14

15

1716

18

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 0.0% -13.0% 840 0.0% -6.7%

West End 2. Kensington & Chelsea 70 -3.4% -9.7% 1,150 -3.4% -9.8%

3. Paddington 63 4.2% 4.2% 1,070 3.9% 1.9%

4. Marylebone 85 0.0% -5.6% 1,690 0.0% -4.8%

5. Mayfair 110 0.0% -8.3% 2,500 0.0% -9.1%

6. Noho, Soho & Covent Garden 85 0.0% 0.0% 1,590 0.0% -3.6%

7. St James’s 110 0.0% -8.3% 2,500 0.0% -7.4%

8. Victoria, Westminster, Knightsbridge & Belgravia 73 -3.3% -12.1% 1,260 -3.1% -10.0%

Midtown 9. King’s Cross 75 0.0% -6.3% 1,230 0.0% -1.6%

10. Midtown 65 0.0% -7.1% 1,150 0.0% 0.0%

Southbank 11. Southbank 65 0.0% 0.0% 900 3.4% 2.9%

12. Vauxhall & Nine Elms 53 0.0% -4.5% 690 0.0% -4.8%

City 13. Clerkenwell & Farringdon 65 0.0% 0.0% 1,110 4.7% 3.3%

14. Old Street & Shoreditch 59 0.0% 0.0% 1,020 7.4% 2.0%

15. City Core 65 0.0% -7.1% 1,250 0.0% -3.8%

16. Eastern City Fringe 53 0.0% -4.5% 820 0.0% -3.5%

Docklands 17. Canary Wharf 43 0.0% -10.5% 690 0.0% -11.0%

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

Central London office rental market heat map (Q1 2018)

£100+

£90-99

£80-89

£70-79

£60-69

£50-59

Sub £50

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.

Source: Cluttons

Cluttons London office market outlook, Spring 2018

© Cluttons LLP 2018. This publication is the sole property of Cluttons LLP and must not be copied, reproduced or transmitted in any form or by any means, either in whole or in part, without the prior written consent of Cluttons LLP. The information contained in this publication has been obtained from sources generally regarded to be reliable. However, no representation is made, or warranty given, in respect of the accuracy of this information. We would like to be informed of any inaccuracies so that we may correct them. Cluttons LLP does not accept any liability in negligence or otherwise for any loss or damage suffered by any party resulting from reliance on this publication. 2102

For further details contactFaisal DurraniHead of research+44 (0) 20 7647 7166faisal.durrani@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 investment management+44 (0) 20 7647 7234 jamie.mccombe@cluttons.com