Henderson Global Investors' London office analysis and outlook (UK)

In its latest London office report, Henderson Global Investors examines the factors underpinning the recovery in rental values and addresses the question: 'Can these rates of growth be sustained?' It concludes that, in the short term, rental growth is likely to stall in line with a slowing in the global economy and a reduction in requirements for large buildings.

However, a confluence of factors should come together to generate a prolonged period of buoyant growth over the medium term.

The report observes a number of trends in the current leasing market:

  • The peak in vacancy in the current cycle was a lot lower than in previous market corrections, notwithstanding the severity of the recent economic crisis. This is because firms have held on to staff where possible and have cut wages and salaries instead. We have not therefore seen the dramatic rise in second hand availability that frustrated the market balance in past downturns.
  • Rent levels are already rising strongly, particularly in the City; the trough was actually reached much earlier than expected at the end of 2009. This partly reflects pent up requirements from bigger occupiers who are concerned about the receding development pipeline.
  • Rent-free incentives are reported to be reducing.
  • The recovery in rental values has not been restricted to prime buildings and is more broadly based.

It also considers the following influences on rental values in the future:

  • A return to employment growth will be an essential ingredient for accelerating rental growth. The slowing in the UK economy and public sector job cuts should reduce take up levels in the short term, especially with many large requirements now satisfied.
  • However, rental growth is only expected to slow rather than to reverse. London should be able to ride the difficulties at home because of its significant exposure to global markets.
  • Take up should therefore moderate, from current buoyant levels but remain resilient; Henderson is particularly encouraged by the continued improving trends in small and medium-sized City lettings, suggesting churn is returning to the broader market.
  • New supply is evaporating and employment levels are expected to stabilize in 2011 and resume growth by 2012.
  • An estimated 2 million ft² (approx. 186,000 m²) of space could be subject to churn between 2013 and 2015 as long leases signed on buildings in the mid to late 1980s expire. In total, 5 million ft² of space could be affected
  • Central London offices are expected to outperform the wider UK property market return as a result of strong rental growth.
  • The main growth phase is expected between 2012 and 2015; Henderson forecasts City prime rents to rise to £68/ft² by 2015, surpassing their previous peak. West End top rents are projected to reach £116/ft² over the same period.

Andy Schofield, Research Manager at Henderson, believes that, assuming there is no further downward movement in yields, sound fundamentals should drive returns on Central London offices well ahead of the wider UK property market.

However, he adds that: "This rosy view of the underlying fundamentals of the leasing market must be considered in the context of a very difficult terrain for institutional investors, particularly those competing with overseas money for primer longer-leased properties. A greater risk appetite and a good eye for asset management will be essential to realising performance, as will access to off-market product.

"Current pricing is already starting to look keen on riskier products and there may be some potential volatility in pricing, opening up potential acquisition opportunities over the next 18 months."

Source: Henderson Global Investors

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