No Other City Can Steal London's Office Market Crown

Brexit be damned: The prognosis for London’s office market is getting better and better.

Fewer jobs will be relocated than previously feared. The peak in vacancy rates will be lower than previously predicted. And no city in Europe, or indeed the world, is well-set enough to steal London’s position as one of the pre-eminent destinations for businesses and investors.

That is the analysis of real estate research firm Green Street Advisors. In its new report, Delicately Balanced, it argues that while rents and capital values for London offices will dip in 2019, unless there is a major economic or political shock, this will not be anything to frighten the horses.

“With only modest relocations relative to initial expectations since the referendum, and a geographical spread of bank and functions moves, there appears to be no winner-takes-all that can threaten London's dominance,” Green Street Managing Director Hemant Kotak said in the report.

“Currently financial firms occupy around 25% of the space in London, and diversifying away to other sectors is positive — albeit competition amongst Continental cities [for banking jobs] continues to favour London for the foreseeable future.”

Kotak said that German cities have the best medium-term prospects for rental growth, but the investment market in these cities is illiquid relative to London. New York has a poor balance between supply and demand in comparison, he said.

Estimates of banking job losses related to Brexit vary enormously. Based on evidence so far, Green Street predicted job losses are unlikely to be more than 5,000 by the end of 2019, and this would equate to 600K SF of negative net absorption. Ultimately, over a five to seven-year period, up to 25,000 jobs could be relocated in total, amounting to negative net absorption of nearly 3M SF.

Green Street said its estimate for new medium-term supply of office space had increased since March 2018, with a 9% increase in 2020 and a 5% increase in 2021. But it said that net supply of new space was only rising to around 1%, around the long-term average, rather than there being any potential for oversupply. It added that if Brexit did cause a fall in demand, many of the schemes slated for development in coming years would be put on ice.

As a result, Green Street said it had reduced its estimate of peak City vacancy rates from 8.6% to 7.3%, with that figure being reached in 2019 and 2020. West End vacancy rates will peak at 4.1% in 2021, it forecasts.

There are some downsides in terms of the medium-term prospects for office rents: The boom in flexible office operators creates volatility. Operators are likely to start going bust in 2019 and beyond, and the successful operators are stealing market shares and exacerbating the trend toward denser office occupation. The growth in submarkets like Stratford or King’s Cross is lowering barriers to entry for office developers.

But broad-based demand from tech occupiers, which have taken 4.6M SF in the past year, and financial services firms, which in spite of Brexit have taken 2.3M SF, continue to keep London resilient.

On the investment side, as, Kotak said, returns of “mid-5% ain't bad in a low return world”.

Investment volumes are being supported by a smaller number of larger transactions, primarily undertaken by Asian investors, and for poorer quality properties “bidding tents are thinning out and the risk is values are impacted to a greater extent”.

“Near-term Brexit concerns aside, London offices offer fair return prospects and deep liquidity,” Kotak said.  

To hear from top investors and developers active in the London office market come to Bisnow's London State of Office event on 12 September.