The latest JLL Central London Office Market Report (Q2 2018) shows that despite growing political uncertainty, both the leasing and investment markets remained buoyant in Q2. A raft of major investment transactions took overall volumes to £5.3 billion, making it the most active individual quarter since Q4 2015. Quarterly take-up was robust, taking H1 leasing volumes to the highest since 2015, and with under offers at a 10 year high, we expect a strong H2. Heightened levels of pre-leasing is rapidly eroding the level of available future supply, bringing the balance of supply and demand into focus:
Political turmoil fails to derail economy
Despite Brexit negotiation deadlines approaching, there is still a high degree of uncertainty about the UK’s future relationship with the EU, its largest single trading partner. While the Government had appeared to reach a consensus on how to proceed with the ‘Chequers agreement’, subsequent senior cabinet resignations threw this back into doubt.
While economic growth has slowed slightly over the past few months, the overall picture is one of resilience. Output growth is expected to rebound a little in Q2 after weather impacted the first quarter, with annual growth forecast to be 1.3% and 1.4% for the next two years respectively. Inflation has moderated after last year’s currency driven spike, but remains above the Bank of England’s 2.0% target which, combined with a continued strong employment picture, led to a 25-basis point increase in base rates in August. This is unlikely to impact property yields given the spread over gilts, which is signficantly higher than the historic average.
Central London market remains buoyant
After a robust first quarter of take-up across Central London, Q2 saw a further 2.7 million sq ft let, 9.0% ahead of the 10 year quarterly average. This brings the H1 total to 5.1 million sq ft, the highest since 2015 and 13% above the long term average. The City was the strongest performing market with 1.6 million sq ft of take-up, while in the West End there was a shade under 1.0 million sq ft leased.
Two key trends have supported this ongoing leasing momentum. Firstly, the level of pre-let requirements is very high across Central London, with low vacancy rates forcing occupiers to address upcoming lease events earlier. As a result, over 1.0 million sq ft was pre-let in Q2, accounting for 38% of take-up. In addition, flexible office providers remain very active, continuing the rapid expansion of the sector, with over 650,000 sq ft acquired in Q2, accounting for 24% of take-up.
For the second consecutive quarter, under-offers have hit a 10 year high, with 3.7 million sq ft currently under offer, including 2.1 million sq ft in the City. This suggests the current levels of leasing will continue at least through the remainder of 2018. Overall demand has dipped a little but active demand is broadly stable, with a reduction in the West End mitigatedby an uptick in the City and East London.
Tight supply conditions continue
Overall supply fell marginally to 10.0 million sq ft as availability remains restricted across Central London, with the vacancy rate stable at 4.8% over the last two quarters. This is mirrored in the West End where vacancy is flat at 4.0%, while there has been a slight dip in vacancy to 4.6% in the City and 8.7% in East London.
New build supply is severely limited, with the new vacancy rate standing at a 15 year low of 0.4%. Recently completed new stock has been quickly absorbed, while the strength of pre-leasing is reducing the anticipated level of speculative development reaching the market in the future. Despite this, there remains a healthy pipeline of new stock expected to complete over the next 18 months, headlined by AXA’s 1.3 million sq ft at 22 Bishopsgate, EC2.
Bumper quarter of investment driven by big deals in the City
Following a slow start to the year, a raft of major transactions in Q2 took overall volumes to £5.3 billion, making it the most active individual quarter since Q4 2015 and the second strongest Q2 on record. This brought investment volumes for the first half of the year to £7.7 billion, still 11% down on the strong H1 last year, but 22% ahead of the 10 year H1 average.
This was led by the City where £3.6 billion was transacted, with a number of major deals headlined by CK Asset Holdings’£1.0 billion purchase of 5 Broadgate, EC2 and Ho Bee Land’s £650 million acquisition of Ropemaker Place, EC2. The five largest deals in Central London were all in the City and amounted to £2.6 billion, almost half of the overall total. East London also saw a significant increase in activity in Q2 with four deals totalling £658 million, more than half of 2017’s total annual volumes.
Overseas buyers continue to dominate the Central London market, accounting for 78% of volumes in Q2. Despite making the largest purchase of the year, Hong Kong buyers have become more discerning overall, with Sterling appreciation, changes to debt arrangements and reduced barriers to entry in China all contributing to this. South Korean buyers are now starting to come to the fore, with four deals since December totalling £1.1 billion and more activity expected.
Prime yields remained stable at 3.50% in the West End and 4.25% in the City. Secondary yields appear to be softening with increasing divergence between prime and secondary expected in 2018.
