LOMA Q2: Hunting for silver linings

Troubling late-cycle economic indicators and an incessant political maelstrom contributed to a subdued opening half of the year for London’s office market. Investment activity shrank considerably compared to a year earlier and core take-up dropped as businesses pressed pause on expansion. Headline figures from Radius Data Exchange show that investment in the sector totalled nearly £2.8bn in the second quarter, taking the six months to the end of June to a total of £4.1bn. That represents a 43% drop against the first half of last year – and reflects a similar percentage drop on the five-year H1 average for overall spend. On the occupational side, a total of 2.9m sq ft was transacted in the second quarter – a jump of 13% on Q1 take-up but down by 10% on the five-year quarterly average. This gives a total of 5.5m sq ft of new space let for the first six months of the year, down by 9.5% on the same period in 2018, and down by 6.3% on the five-year H1 average. These figures have been reached against a backdrop of downbeat economic signals. The end of June brought with it a deluge of grim domestic data. IHS Markit recorded the weakest UK construction purchasing managers’ index since 2009, as well as a decline in UK private sector output for the first time in almost three years. Figures from KPMG and the British Retail Consortium revealed that consumer spending is at its weakest since the mid-1990s, while UK productivity has fallen for a third consecutive quarter. Some form of economic contraction has been anticipated, given that most advanced economies are starting to see growth slowing after a post-crisis period of sustained recovery. However, these indicators all coming simultaneously now give rise to concerns that the next recession could be fairly close at hand. Added to these is broader global trepidation off the back of trade tensions and shallow yield-curve inversion for US treasury bonds. Then, of course, there is Brexit. Following Theresa May’s resignation and the subsequent election of Boris Johnson as prime minister, a “no-deal” exit from the European Union is now increasingly likely. Johnson insists that the UK will leave the EU on October 31 come what may, and EU leaders appear steadfast in their conviction that no further negotiations or concessions to the existing withdrawal agreement are likely to come to pass in the interim. So far, so downbeat. And yet even this doom and gloom has failed to shut down activity in London’s office market entirely. Even if it appears resolutely sedate on the surface, there are reasons for positivity. In the leasing market, the data indicates that two out of the six main submarkets showed an increase on long-term take-up averages to buck the wider London trend during the second quarter. Docklands was boosted to its best quarterly take-up volume since late 2016 by the 360,000 sq ft preletting to the European Bank for Reconstruction and Development (EBRD) at 1-5 Bank Street, E14, in a deal that accounted for 74% of Docklands take-up during the quarter and 12.4% of Q2 occupational activity across London as a whole. The West End also enjoyed a healthy quarter following a strong opening three months of the year, with almost 800,000 sq ft of Q2 take-up. That represents a 6% uplift on the five-year quarterly average (see table). The submarket saw the third-largest deal of the quarter with 102,500 sq ft let to G-Research at Soho House, W1, and accounted for 119 of the 318 individual transactions that completed in Q2. One of the major developments to come out of the West End (and, indeed, the entire London market) over the period was the new record rent for London office space set when Steadview Capital agreed a £250 per sq ft deal at 30 Berkeley Square, W1, in April. This was particularly intriguing in light of recent statistical patterns on Mayfair rental values. Figures from our consensus panel of agency experts indicate that from around the middle of 2016, rental tone for grade-A space in the area began to trend downwards, back towards levels seen in early 2014, while other submarkets saw something more akin to a plateau following the Brexit referendum. (see chart). At the mid-point of last year, however, Mayfair rents began to slowly rebound – and the record-breaking Berkeley Square letting has, in part, precipitated a sharp uptick back above the early 2014 base level for the area. This, along with grade-A increases in Canary Wharf, City Core, Paddington and Victoria, has meant a quarter-on-quarter bump across London to the tune of 2.2%; and an annual uplift of 2.9% against this point in 2018. Those are the strongest such increases seen from the rental panel since 2015 – and a third consecutive quarter in which aggregated rents have risen across London. New demands, new space Upward shifts in headline rent are one determining factor for these rises, especially when other market forces such as scarcity are less influential than they have been in the past in facilitating upward pressure on rental tone. Radius Data Exchange’s availability rate for London remained at just below 7% at the end of June – barely moving from the previous quarter, and so aside from headline rental shifts, other factors are clearly underpinning rent rises. One such factor is an increasing focus from occupiers on high-grade space in light of modern office requirements – such as ensuring buildings have the best connectivity conditions and that they meet the evolving workplace demands of employees regarding wellbeing and environment control. Existing second-hand spaces may, of course, be able to offer some of these elements adequately, either as part of a retrofit or simply by virtue of quality original design. But leasing data from the second quarter points to a continued drive from occupiers towards new-build units. Space that is currently under construction accounted for 27% of quarterly take-up in Q2 – a greater proportion than in 19 of the past 20 quarterly periods. In the most recent quarter, four of the largest seven individual transactions were for new space. Consolidation is something of a buzzword across the office sector, highlighted by BT’s recent announcement that it will look to shrink more than 300 offices across the country down to 30 in the largest such operation ever seen on these shores. In addition to the appeal of modernity, new-build spaces are powerful when it comes to this approach. Such properties can give a refreshed footprint to occupiers seeking to use their physical space in a more efficient manner. These occupiers may also be more comfortable with higher rents if it means that their overall costs for space are not exorbitant in comparison to any piecemeal operation they may have had prior. Given these trends, the coming quarters may continue to reflect strong leasing activity for development space. There is a healthy enough pipeline of around 16.7m sq ft currently under construction and a further 19.5 m sq ft of new space at permission, which could come through if prevailing economic conditions are supportive, and if developers don’t become spooked by other factors. A strong propensity for regenerating business space should really be considered part of London’s “fundamentals”, which were often referred to in the aftermath of the Brexit vote as evidence that the capital could insulate itself from the repercussions of the UK’s exit from the EU. In recent quarters, the volume and ambition of development work being undertaken has undoubtedly helped London’s letting performance – as well as contributing to this recent recovery in grade-A rental tone across the city. But if developer confidence begins to stutter, there is a latent risk of market stagnation, which would feel like a lost opportunity. Finance bounces back Along with boosting the Docklands’ overall volumes, the EBRD deal anchored the financial sector’s rebound in Q2 to dominate sectoral take-up. Financial firms accounted for a third of overall letting volumes, the highest such proportion since the second quarter of 2015, when the sector took a 39% share. The previous four quarterly analyses saw finance command just a 14.5% share of letting volumes on average – a historically low share of take-up for the sector. Nonetheless, active demand and requirements remained relatively high even through a period in which firms chose to “wait and see” rather than strike deals. Looking at current occupier lease events between 2020-25, financial firms come out ahead of any other sector in terms of space up for renewal across London. So for lease-driven demand alone, the sector should, in theory, continue to push forward with new requirements, although the form those requirements take will still hinge on how Brexit unfolds. While a few financial occupiers have thrown off the shackles of the “wait-and-see” approach, the same cannot be said for buyers or sellers. The first half of the year was fairly quiet, with some assets being withdrawn from potential sales and others taking longer than anticipated to sell after hitting snags during the process. A rebound in spend volumes from Q1 was largely propelled by the fact that Radius Data Exchange records Citigroup’s £1.1bn acquisition of 25 Canada Square, E14, as an April completion. That deal helped the quarterly volume to £2.8bn – down by 39% against Q2 2018 – and the H1 figure to £4.1bn. Looking towards the rest of the year and beyond, there remains the possibility that a “no-deal” Brexit could unlock investment potential from overseas buyers, which could look to use any tumble in sterling to acquire discounted assets, echoing the period following the EU referendum. Domestic investors have seen their share of investment activity edging upwards in recent quarters, which suggests that the overseas cohort may be keeping its collective powder dry for such an eventuality, with little to lose out on in the meantime as the volume of assets on the market remains relatively shallow, as well as there being a dearth of distress on which to capitalise. Leasing league tables Q2 2019 Cushman & Wakefield climbed from sixth place in Q1 to take top spot in the City core this quarter, securing a 33% market share through just over 305,000 sq ft of disposals. Key to this victory were three large preletting deals, the most significant of which came in the shape of Brewin Dolphin’s 116,000 deal at 25 Cannon Street, EC4. JLL was the most active agent in the City by volume of transactions completed for the fourth consecutive quarter. The largest of those came at Senator House, EC4, where Quilter took just under 94,000 sq ft, helping JLL to a 28.5% market share in second place. The Senator House space was jointly disposed with Allsop, which climbed from 10th place in Q1 to storm the top five in the most recent quarter with a market share of 11%. The second quarter marked an eighth win in a row for Colliers International in the City fringe submarket. The firm secured a 37.5% market share through 116,000 sq ft of disposals spanning 20 individual transactions to sew up the victory. The largest of those 20 transactions came at Discovery House, EC1, in the form of a 21,000 sq ft of space for WeWork, which it jointly let alongside sixth-placed BNP Paribas Real Estate. Cushman & Wakefield climbed from 10th place in the City fringe in Q1 to a podium finish this time, helped by a pair of 18,000 sq ft deals for QA Learning at International House, E1W; and for Ebiquity at Hertford House, EC1, which it jointly disposed with Colliers International. An area of London defined by large-floorplate transactions, Docklands’ leasing league table for Q2 crystallises that dynamic – all three agents which acted on the largest deal of the year secured comparably mammoth market share figures in the podium positions. CBRE supplemented a 360,000 sq ft transaction for the EBRD at 1-5 Bank Street, E14, with a further five lettings to set it apart from joint agents – the most significant of which was at the Import Building, E14, where it disposed of 32,700 sq ft alongside sixth-placed Allsop. Two jointly-let deals totalling 35,000 sq ft at the Columbus Building, E14, for Revolut and Smartest Energy enabled Knight Frank and Savills to complete the top five, with BH2 also acting on those transactions to edge JLL into third place. A subdued second quarter in the Midtown submarket saw CBRE secure top spot with just over 53,000 sq ft of disposals across the three months, enough to give it just over 25% of the market total and enjoy a quarter-on-quarter climb from fourth to first place in the process. The firm advised on three of the largest four deals recorded in Midtown in Q2, including two separate deals totalling 35,000 sq ft at 90 Long Acre, WC2, to Ivxs UK and Masthaven, which were jointly disposed with Colliers International, and 13,300 sq ft to law firm Haynes and Boone at 1 New Fetter Lane. Farebrother also acted on that Haynes and Boone deal, which propelled it to third place from eighth in last quarter’s standings. Farebrother was also the most active agency by deals volume in Q2, having advised on eight individual lettings. Submarket specialist Union Street Partners wrestled back its Southern fringe crown in Q2, having lost it last time out to BNP Paribas Real Estate. It acted on eight individual deals totalling just over 67,700 sq ft of space to secure a comprehensive 35% market share at the top of the tree. It advised on the largest deal in the submarket this quarter to help spearhead the success, a 33,000 sq ft deal at 25 Lavington Street, SE1, to Sustainable Workspaces. Knight Frank climbed from fourth place in the Q1 standings to triumph this time out, with 16 individual deals spanning more than 283,000 sq ft to give it a 36% market share. Anchoring the victory were the largest three lettings in the West End this quarter, namely the 102,000 sq ft deal for G-Research at 1 Soho Place, W1; Parliamentary Estates’ 96,000 sq ft of office space at Westminster City Hall, SW1; and Liberty Commodities’ 37,000 sq ft letting at Hobart House, SW1. JLL and Cushman & Wakefield also acted on the G-Research transaction – with the former climbing from 10th place in Q1 to come in second this quarter. Tuckerman jointly brokered the deal at Westminster City Hall which, along with eight other deals, helped it climb from fifth place last quarter to third on this occasion. Having placed in the top five for every single submarket, JLL’s consistency sees it storm to the top of the standings for London office lettings in Q2 – securing a 30% market share through more than 900,000 sq ft of landlord disposals to win its first quarterly title since Q3 2015. Critical to JLL’s success was advising on three of the largest five deals across the quarter. It was also one of only three agencies to surpass the 40-deal mark during the same period. CBRE came in second place, advising on more than 747,000 sq ft during Q2 to secure a 24.8% market share. BH2, meanwhile, climbed from ninth place overall in Q1 to complete the top three this time, with the 19% market share largely down to its involvement in the mammoth EBRD deal. CBRE advised on more than £1.6bn of investment transactions to secure top spot in the Q2 investment league table, with a market share of 36%. It advised on the £1.1bn Citigroup deal at 25 Canada Square alongside second-placed Cushman & Wakefield; as well as the second-largest deal of the quarter at Waterside House, W2. Third-placed Knight Frank and fifth-placed Eastdil Secured also acted on the Waterside House transaction; while Allsop jumped from sixth to fourth, partially due to advising Harel Insurance on its sale of Ibex House, EC3. To send feedback, e-mail graham.shone@egi.co.uk or tweet @GShoneEG or @estatesgazette