LOMA Q3 2019: Proceed with caution

LONDON OFFICES MARKET ANALYSIS Buyers and sellers are choosing to play it cool as the political turmoil surrounding Brexit unfolds. However, occupational activity maintains momentum, underpinned by demand for grade-A space. Some significant individual transactions in the third quarter of 2019 brought improvement to London’s occupational market as activity rebounded from a relatively sedate opening half of the year. However, investment volumes remained steadfastly suppressed amid caution from both buyers and sellers. The period from July to September saw occupational activity reach 3.4m sq ft, according to figures from Radius Data Exchange – a rise of 17% against last quarter and an increase of 6% on the five-year quarterly average. Investment, meanwhile, totalled £1.9bn – a 62% drop on Q3 last year. That means that, so far, overall 2019 volumes are 51% down on what was transacted in the opening nine months of 2018. As always, the political and economic reality in which the market has to operate is having an influence on activity – and while certain developments during the quarter could be seen as positive, the overarching environment of uncertainty continues to be pervasive. Economically, some small comfort has emerged after worrisome national data provided the backdrop to our half-yearly market analysis during the summer. Clement GDP estimates for July and August arrived to foreshadow a likely rebound in official quarterly growth following the Q2 contraction. However, PMI indices and suppressed confidence levels from both consumers and business continue to cast doubt on the medium-term resilience of the UK’s economy on the whole. Looking beyond this quarter, the IMF’s half-yearly WEO survey did not recalibrate its April predictions over Britain’s future growth prospects, despite downgrading global growth forecasts off the back of escalating trade tensions and fears over protectionism, as well as separately espousing concerns over corporate debt levels. It left the UK forecast for 2019 and 2020 at 1.2% and 1.4% respectively; albeit predicating this forecast on achieving an “orderly exit” from the European Union. The prospect of such an exit remains eminently possible at the time of writing – albeit with prime minister Boris Johnson pausing parliamentary process for his deal, and the EU considering whether to grant an extension in order for the necessary legislation to pass through parliament to allow a formally negotiated exit. However, indications are that a general election could follow an EU-granted extension, eliciting even more uncertainty going into the final stretch of 2019. Avoiding a no-deal scenario under any government will enable a transitional phase to begin as soon as practicable, during which time the UK will seek to formalise future trading arrangements with the bloc – of which the most vital part for London’s business coterie will likely be the detail and extent of access to the common market for professional services. Looking at business sentiment in the capital over the three-month period, the London Chamber of Commerce and Industry’s quarterly economic survey indicated that while orders and sales increased compared to recent figures, ongoing political uncertainty and increasing costs for both materials and staffing are exacting pressures in terms of preparedness for the potential of new operational realities and bottom-line projections in the short term. While Radius figures for office occupational activity against long-term quarterly metrics were positive, the 3.4m sq ft let actually reflected a 1% drop on the equivalent period last year, largely due to the fact that Facebook’s mammoth 615,000 sq ft deal at King’s Cross Central, N1, came at this point in 2018. Nothing quite matching that scale was let this time around but four transactions above 100,000 sq ft anchored strong statistical performance at submarket level. BT’s long-anticipated London relocation was confirmed in July, with the telecommunications giant agreeing to take 328,000 sq ft at One Braham, E1. It was the quarter’s largest individual deal – and enabled the City fringe to see a 58% rise on the five-year quarterly average and boost year-to-date performance above long-term averages for the submarket after tracking behind the half-yearly trend in H1. WeWork made what may turn out to be its last hefty London leasing deal until widely publicised internal wranglings are resolved and future strategies are agreed. The serviced office operator signed for a 287,000 sq ft sublease at 30 Churchill Place, E14, to provide 87% of Docklands’ take-up this quarter and boost the submarket to a quarterly total that is 41% above its five-year average. The City core and West End also saw upticks against both the five-year average and the equivalent period last year with substantial deals for Knotel at City Place House, EC2, and Diageo at 16 Marlborough Street, W1. These helped both areas to see growth figures on Q3 last year as well as five-year and 10-year quarterly averages. For Midtown, the location of the aforementioned Facebook deal a year ago, a relatively subdued quarter on the leasing front saw a 50% drop on the five-year average. Similar figures were seen in the Southern fringe, where just under 80,000 sq ft was confirmed let in Q3, making it the quietest letting period in that area since Q4 2012. Looking at drivers of occupational activity, the trend of under-construction space bolstering letting volumes continued, with more than 30% of quarterly activity coming in schemes currently being built – the largest such proportion since Q4 2008. This has meant that 26% of the space let so far in 2019 has come in space which was under-construction at the point of transaction – the most acute influence for development space in yearly take-up since 2007. Following the occupational trend, construction activity for London offices has been reasonably strong so far this year, with substantial starts at 8 Bishopsgate, EC2, and King’s Cross Central, N1, supplementing high volumes in Q4 2018 to give rolling 12-month construction starts of 5.3m sq ft – the highest figure since the beginning of 2017. However, with almost half of the development pipeline now prelet, much of the new space getting under way is simply satisfying existing occupational agreements. Economic and political realities (if not satisfactorily resolved) remain likely to stymie the flow of new speculative space into the completions pipeline in the immediate term, which may subsequently force larger occupiers to either move any relocation or consolidation plans forward and compete for the space which is available, or rethink entirely and find alternative solutions. One such solution could be an increased utilisation of serviced offices for immediate requirements – and operators of those spaces certainly haven’t been shy in pressing forward with expansion over the past three months. Knotel, Convene, IWG and CBRE’s newly created flexible offering, Hana, have all agreed substantial lettings during Q3 to supplement WeWork’s Docklands deal. Those deals contributed to serviced office operators commanding the highest share of office take-up across the quarter with 30% of overall activity, the first time that we have recorded that occupier sector taking the lion’s share of quarterly leasing volumes as a standalone segment, edging tech and financial companies into second and third place respectively. Given the headlines emanating from WeWork’s calamitous cancelled IPO, which culminated in a reshuffling of the senior leadership team and an almost $40bn climbdown in estimated company value, it’s a quite typical quirk of fate for this to be the debut quarter for serviced offices to dominate sectoral take-up in central London. However, it represents another waystation on an exponential growth journey for the sector. For context, serviced offices accounted for 3.3% of occupied office space across central London in 2014 – that share has now grown to 6.7% of the capital’s business footprint – largely as a result of acute demand for good-quality office space to be available on flexible terms in well-located buildings. Our analysis earlier this year underlined that serviced office operators have been the biggest net expanders for office space in London since March 2016, as more traditionally dominant business sectors continue to evaluate how best to segment their office occupation between a consolidated core envelope and a more fluid flexible space. The current level of preletting in London is a result of the desire to obtain the best core offering that can better engender productivity, talent retention and employee satisfaction. Given the headlines emanating from WeWork’s calamitous cancelled IPO… it’s a quite typical quirk of fate for this to be the debut quarter for serviced offices to dominate sectoral take-up in central London Those qualitative factors continue to underpin demand for best-quality core office space, maintaining the recent upward pressure on grade-A rental tone, with average figures from our panel of agency contributors indicating that 10 out of 11 central London enclaves saw grade-A rental tone increase in comparison to last quarter – with Covent Garden the only area seeing no change from Q2. This is the first time since Q3 2015 that the panel has returned data that does not show any single sub-sector across London reflecting a drop in grade-A rental tone compared to the previous quarterly figures. Uplift across London in comparison to last quarter was 0.7% – a deceleration on the growth rate of 2% seen last time out, which was slightly skewed by the associated uplift following the record rent set in Mayfair but which still reflects a 3.7% increase on grade-A rents at this point last year – the largest year-on-year increase seen since the EU referendum. This uptick will be welcome news for both existing owners and potential investors seeking to enter the London market but wider drag factors linked to the economic and political dissonance are continuing to impede purchasing volumes in the capital, despite resolute occupational performance. Investment in Q3 totalled £1.9bn, a 31% drop against last quarter, meaning the rolling 12-month total spend on London offices is now £9.5bn – the lowest since we began this series in mid-2013. There is little dispute across the market as to the level of interest across the investment world for purchasing London office assets – but interest is a precursor to activity only when filtered through the conduit of conditions. Specifically in this instance, one condition affecting sales volumes is a pricing gap that originally reared its head after the EU referendum, with discounts being sought to assuage concerns around uncertainty. Buyers and sellers have remained disconnected enough to temper the flow of new assets coming on to the market, with incumbent landlords preferring to wait out any extraneous factors constraining investor sentiment before actively pursuing new potential sales – a luxury that the strength of performance of London’s office market has offered them – and which is not presently shared by all real estate investors. Begbies Traynor recently published its Red Flag Alert report, in which it indicated that the number of real estate firms in “significant financial distress” has jumped by 16% year-on-year; higher than any other comparable investment sector. Being insulated from such circumstances means the necessity of divestment is absent – a welcome factor but another contributory barrier to converting latent interest into transactional volume. This pricing disconnect is, in fact, a concern for a wider pool of investors, as indicated by PREQIN’s latest survey of investors across alternative asset classes. It showed that 62% of those involved in real estate felt the global market is currently overvalued; with asset valuations ranked as the most prominent challenge among active property investors – 82% of those surveyed cited it as a barrier to generating returns. In years past, the fourth quarter was the busiest period for London office investment volumes. What comes through between now and the end of the year in terms of actual sales volumes and assets coming on to the market will be hugely instructive as to how all of these factors around pricing and sentiment are playing out, and will give us an idea of what to expect across 2020, by which time hopefully the “Godot” of increased political certainty will have arrived. Leasing league tables Q3 2019 CBRE climbed from third place last time out to claim top spot in the City Core submarket, securing a 39% market share through almost 463,000 sq ft of disposals; while JLL advised on 436,000 sq ft across 20 individual deals to secure a 36% market share in second place. Both CBRE and JLL acted for the landlord on three out of the largest four deals in the City in Q3, including two deals measuring 99,300 and 74,600 sq ft at 22 Bishopsgate, EC2, to Convene and Cooley respectively. Acting on roughly 47,000 sq ft of lettings at The Scalpel, EC3, alongside fifth-placed Cushman & Wakefield helped CBRE pip JLL into first place. Third-placed Knight Frank and fourth-placed Savills acted on the third-largest transaction in the City this quarter, which came at 68 King William Street, EC4, in a 61,900 sq ft letting to IWG’s Spaces. After eight successive quarterly triumphs in the City Fringe, Colliers International has finally had its crown wrested away – coming in third place behind victors CBRE and second-placed Cushman & Wakefield, both of which acted on the mammoth letting to BT at One Braham, E1. Further deals at the Johnson Building, EC1, enabled CBRE to nudge ahead of Cushman & Wakefield into top spot – up from ninth position in this submarket last quarter – securing a 51% market share. Colliers retained a space on the podium thanks largely to sheer transactional volume, with 28 individual deals done across the quarter; Anton Page was Colliers’ closest rival by that metric – completing 15 deals to retain its place within the top five. Allsop jumped from seventh position last quarter to fourth on this occasion with its largest letting coming at 20 Bonhill Street, EC2, where it disposed of 51,300 sq ft to law firm Kingsley Napley. A tale of one deal in the Docklands submarket, as BNP Paribas Real Estate jumped to the top of the tree having acted on the subletting of almost 288,000 sq ft to WeWork at 30 Churchill Place, E14; enough on its own to give it an 87% market share in an otherwise quiet quarter in the Docklands. Last quarter’s winners CBRE dropped to 2nd in the table, with its largest disposal being the 14,400 sq ft deal to St James Place Wealth Management at One Canada Square, E14, on which it acted alongside third-placed JLL. CBRE’s third submarket title came in Midtown, where it disposed of nearly 110,000 sq ft across seven deals to take first place with a 43% market share. Key to its success in retaining the Midtown title was acting on the 88,700 letting to Nationwide at the Post Building, WC1, alongside second-placed JLL and third-placed Pilcher Hershman. CBRE’s total of seven individual disposals was only matched this quarter by sixth-placed Farebrother. Kontor leapt into fourth place in the disposals table this time around, having acted on the second-largest disposal in Midtown for 28,900 sq ft to WeWork at 52, Bedford Row, WC1.   In what was the quietest quarterly period in the Southern Fringe in seven years, Union Street Partners’ victory was secured by acting on just over 38,600 sq ft to give it a 55% market share and retain the title it won back last quarter. Disposing of 7,600 sq ft to Cityscape Digital at 7 Bermondsey Street, SE1, anchored this victory, with ten further deals giving it a transactional volume far ahead of any other agency. Second-placed JLL also acted on that deal, as well as representing the landlord on the largest transaction in the submarket this quarter with 8,900 sq ft let to Jellyfish at The Shard, SE1, alongside fourth-placed Knight Frank. A second quarterly victory for Knight Frank in the West End; disposing of just over 232,000 sq ft to secure a 30% market share; with CBRE coming in second with a 27% share of disposal activity having acted on just under 208,000 sq ft of landlord space. Critical to Knight Frank’s victory was acting on the two largest deals within the submarket this quarter – to Diageo at 16 Marlborough Street, W1 alongside CBRE; and to Bridgepoint at Marble Arch Place, W1, alongside third-placed Cushman & Wakefield. Three individual submarket titles and a pair of second-place finishes enabled CBRE to climb back to the top of the disposals league table in Q3 from second-place last time, securing a 36% market share after having advised on more than 1.2m sq ft of landlord space this quarter. CBRE acted on five out of the seven largest individual deals in London – all of which are detailed in the submarket table descriptions; and only Colliers International struck more individual transactions across the period than its 42 completed lettings. Cushman & Wakefield climbed from fourth place in last quarter’s overall standings to achieve a second-place finish this time out, with a 22% market share obtained through 31 transactions totalling 743,000 sq ft of space. Acting on the aforementioned Nationwide letting in Midtown enabled Pilcher Hershman to jump into the top ten this quarter with a market share of 3.6%; while Edward Charles & Partners’ activity on Euston Tower, NW1, helped propel it up into the top ten from 12th place last time out, securing a 2.9% market share through nearly 101,000 sq ft of lettings. CBRE acted on more than £567m of investment transactions to retain its crown in the investment league table, achieving a market share of 19%. It advised on the largest investment deal of the quarter, acquiring the £277.5m 23 Savile Row for Lazari Investments, as well as advising Derwent on the £103m sale of the Buckley Building, EC1. Cushman & Wakefield acted on sales of 81 Newgate Street, EC1, and Salisbury Square House, EC4, to ensure that the top two agents in last quarter’s table remained in place this time around – acting on just under £431m in total to secure a 14% market share. Savills climbed from seventh place in last quarter’s rankings to complete the podium finishers on this occasion with a 13% market share – largely due to advising Mitsubishi Estates on the £260m sale of 8 Finsbury Circus, EC2.   To send feedback, e-mail graham.shone@egi.co.uk or tweet @GShoneEG or @estatesgazette