Rents smashed through £185/sq ft at Green Property’s 8 St James’s Square while in submarkets like King’s Cross rents crept up to highs of £80/sq ft. On the investment side, yields remain at record lows and capital values have even surpassed their 2008 peaks in some locations.
But with previous records being eclipsed, how much room is there now left for growth? Is there a danger the market is overheating - or do the headline numbers mask a more nuanced story?
So far in the first eight months of 2015, £4.2bn worth of stock has been traded in the West End. Data from DTZ - now Cushman & Wakefield - reveals that across central London £12.6bn of commercial property has changed hands. Of this, £9bn was purchased by foreign investors, accounting for 71% of the market.
Fergus Keane, head of West End investment at DTZ, says he thinks the West End investment market is due a strong last quarter and has at least another 18-24 months left to run. “I wouldn’t say that the market is at the top,” he says. “While I definitely think we are moving through the cycle, I do think we have 18-24 months of potential growth left to go. Maybe [there will be] less performance on capital value growth side and more about rental growth. “
Keane says that although yields have come into 3.5% he does not expect these to fall to 3% for “prime rented offices”. “We have a very low vacancy ratio, so rental growth is coming through,” he says. “We also have very little supply [of investment stock] currently - people don’t want to sell as it becomes too difficult to replace these assets in a market where global equity of nearly £15bn is targeting the West End. We’ve also got a lot of global equity targeting Midtown, and it’s same for the City.”
Keane says there is unlikely to be a slowdown in the market while property continues to remain attractive when compared with low-yielding government bonds and stocks, particularly given the recent market volatility in China. He adds that 2015 is very different from 2008 when banks were lending at a 90% to 95% loan-to-value (LTV) ratio.
“When you also factor in the fact that most commercial large deals are 50% LTV, maybe 55%, and the all-in margins the rate that the bank is charging can be sub-3%. These prime assets can be cash flow positive from day one. Then if you believe the rental growth picture and look at other asset classes, like the rate on 10-year gilts or cash, along with the volatility of the equity markets, then this should continue to support the pricing of the West End investment market for the next 18-24 months.”
Ker Gilchrist, head of London investment at Quintain, who advises the West End of London Property Unit Trust (WELPUT), is also bullish on the prospects for the West End.
“We’re taking comfort from the fact the rental growth we’ve seen has been fuelled by steady occupational demand rather than by a wall of over-heated occupational competition for that space,” he says.
“Couple that with the fact that the development pipeline we have now is generally speaking controlled by rational equity-funded landlords rather than debt. We believe that any future supply is going to be released in line with demand rather than on a knee-jerk basis.”
He adds that the wave of global capital targeting London and the West End in particular means there is always a buyer for WELPUT’s finished product. This was evident from WELPUT’s recent deals: GWM Group, backed with mainly Italian capital, exchanged contracts to buy 16-17 Connaught Place from WELPUT for £110m in August, while a private Asian client of Jeremy Titchen’s Rockhopper Real Estate snapped up One Chapel Place for £60m in January.
“The last two WELPUT sales we’ve undertaken have been to new entrant first-time buyers,” Gilchrist says. “That’s a really important point, we’re not dependent on every asset being bought by UK institutions any more — it’s such a wide base of credible equity-based buyers.”
Patrick O’Keeffe, head of London markets at Bilfinger GVA, also argues that tenant demand in the West End is in “rude health” — although he says it thins out at the top end.”Tenant demand is in its best health at buildings up to about £80/sq ft. That is the strongest market, where the best depth of demand is; in fact even at up to about £90/sq ft the market is in good health with good demand and buildings being taken at that £60-£90/sq ft bracket. As soon as you get substantially over £100/sq ft, the air gets thinner.”
O’Keeffe, who has been part of the advisory team on a number of recent lettings at Qatari-owned Park House on Oxford Street, argues the market is being underpinned by the limited supply coming through as well as a loss of space to residential. He believes the market will find its level if occupiers are priced out and leave as it will prompt space to come back on.
But some developers and agents are taking a more cautious tone. Daniel Van Gelder, co-founder of Exemplar, warns that the shortage of office space coming through is now almost at “critical” levels and says there is “no question” the market is getting hot.
“Given there’s almost no supply now in the core West End, one can only assume that rents are going to continue their upward climb,” he says. “The tenants and potential occupiers we are talking to now are not occupiers looking for space this year or next but for 2017/18 because there’s a huge dearth of supply and they know how long things are going to take to deliver.”
The shortage of space has been exacerbated following a number of chunky deals this summer, including King Digital Entertainment taking 65,000 sq ft at Resolution Property’s Ampersand building in Soho, Facebook entering an exclusivity period to pre-let the whole of 1 Rathbone Square and Chenavari taking the top floors of Park House.
Van Gelder, who is also chairman of the Westminster Property Association, says that despite the favourable supply-demand dynamic office developers in the West End are facing three key challenges: construction cost inflation; competition from foreign developers who do not need to turn a profit when buying sites; and competition from residential developers.
Likewise, Land Securities’ head of commercial Kaela Fenn-Smith, says that while the REIT is currently seeing strong demand for office space in its Victoria holdings, including as pre-lets - previously unusual in the West End - there is a question mark over what happens when the supply shortage eases.
“Since 2009, the supply of new space to central London has been low and accompanied by falling vacancies,” she says. “Beyond 2016, supply in central London is forecast to increase which - with increasingly footloose occupiers - has the potential to impact vacancy rates, rents and yields in the West End.”
These footloose occupiers, while a boon for broader central London, could result in tenants leaving the West End for cheaper space or better-connected locations farther afield.
Andrew Barnes, director of central London tenant representation at JLL, says large corporate occupiers are talking about their options as rents head upwards and Crossrail makes commutes across London easier. Barnes adds: “They are starting to say: ‘Yes there is a war on talent and we do have to have good office space but does it have to be in the West End if it’s going to cost us more than £85/sq ft’?” Companies may begin revisiting the ‘hub and spoke’ model rather than keeping their staff in one location.”
The top end of the office market has grabbed headlines this year in St James’s and Mayfair. Green Property let the 3,000 sq ft top floor of 8 St James’s Square to private family office Helly Nahmad, owner of the eponymous Mayfair art gallery, at a stonking £185/sq ft, as well as the larger floor below to SG Hambros Bank - part of Société Générale - for £150/sq ft. Other landlords quickly followed suit in hiking their rents above the previous market peak of around £115/sq ft.
Barnes says this end of the market, in particular, is showing signs of affordability problems as demand remains thin, particularly for more than 10,000 sq ft.
“I think you might find that, come the new year, it wouldn’t surprise me if you find landlords on super prime space, particularly the larger floorplates, offering more attractive packages, and looking at how they structure rent/rent-free ,” he says.
While the West End office market is not heading off a cliff any time soon, there are some early signs of tension in the market as rents rise and supply dwindles.