Research Briefing. Rent Review Outlook. Spring 2009

Transcription

1 Research Briefing Rent Review Outlook Spring 29

2 Rent Review Outlook Spring 29 Introduction Welcome to our Rent Review Outlook, which is produced at a time of major turmoil in the economy and the commercial property market. The economic recession is now firmly feeding through to occupier market performance, in terms of occupier demand, void rates, and prevailing rental levels. For landlords this comes on top of the major upward shift in property yields that has occurred over the last 18 months. Our aim is to provide a guide for both occupiers and landlords on rental trends, and show that current market conditions are creating significant opportunities for both tenants and landlords to negotiate more beneficial lease terms. The bulletin examines recent rental trends and forecasts across the retail, office and industrial sectors. However, we have placed a particular focus on the central London office market, where the property cycle is the strongest and movements in rental values are now particularly marked. Summary of key findings Key Trends As rental values fall, 29 will see a rapid change in the prospects at rent review. Currently, average rental values are still higher than five years ago. By the end of the year, the reverse is likely to be true, with rental values in most sectors likely to be either at similar levels to, or lower than, five years ago. Central London offices will see the biggest shift in favour of the tenant. As rental values fall, an increasing number of tenancies are becoming over rented. This trend will continue as the recession feeds through increasingly to rental performance, with all sectors expected to see falls in average rents this year. Void rates are rising and will continue to do so during 29. The longer term outlook is for average rents to continue to fall throughout 21 and 211, tipping the market further in favour of the tenant. Our report highlights significant differences in rental performance between the different sub-sectors within the central London office market. In certain submarkets net effective prime rental values are still considerably above their level of five years ago, against the overall market trend. Major differentials in performance at local level will also occur across the rest of the commercial property sector, with rental uplifts for specific locations and properties varying widely from market averages. Key Opportunities As the potential uplift at rent review reduces this year and market rental levels increasingly fall below the rent passing, traditional thinking might suggest that nothing happens. However, this is far from the case an over rented property is a problem for both the landlord and the tenant. The landlord s problem if a property has a rent review this year, there is an increasing prospect that there will be no rental uplift, and thus no prospect of any uplift until the next review in 214. This may have an adverse impact on the capital value of the property. The landlord may also be worried about the tenant going into administration. The tenant s problem as reviews are normally upward-only, the tenant may well be paying more than the open market rent for space, at a time when cost savings are more vital than ever. An over rented property also adversely impacts on the tenant s ability to sub-let or assign the property a particular problem in the current market if downsizing becomes necessary. The opportunity in cases where there is a break clause in the lease, the opportunity is provided for the tenant to surrender the break clause in return for a reduction in rent. This not only benefits the tenant through lower costs, but benefits the landlord by providing a guaranteed income for a longer term and a potential uplift at the next review in 214, increasing the attractiveness of the investment. Where there is no break clause, an extension of the lease term in exchange for a lower rent provides an alterative. The broader picture we believe that there is no reason to link approaches to specific events such as rent reviews and break clauses. Indeed, the current economic climate provides a major opportunity to look at restructuring leases to the mutual benefit of both landlords and tenants. 2 GVA Grimley Ltd 1 Stratton Street London W1J 8JR

3 Rent Review Outlook Spring 29 UK leasing market trends Trends in average UK rental values The commercial property market is cyclical and rental values over the five-year period relevant to most rent reviews change considerably according to market conditions. The following chart shows annual rental growth in a long-term context, illustrating how cyclical the market is. A key feature is the difference in performance between sector, with the office sector having a much more pronounced cycle (due mainly to the significant impact of the volatile central London office market on the figures), compared with much flatter and more synchronised cycles for retail and industrial property. Annual Change in average UK rents Source: IPD Annual Index Of 3key importance is how rents have changed over the last five years. The next chart shows this (as an index with 23 as 1) using 2 the IPD Monthly Index. This illustrates the sharp rise in central London office rents compared with the more gradual increase in rents in the rest of the commercial property sector, with high street retail property seeing a steeper increase than change pa regional offices and industrial property It can be seen that rents in all sectors are currently higher than five years ago, although falls are now occurring across the board, - again most notably in central London offices. This is beginning to erode the increases that have occurred since Rental Change during 29 () Annual change in average UK rents Source: IPD Rental index Last five years Rental Index - Last Five Years Annual Change in average UK rents Source: IPD Annual Index Average Rental Growth Forecasts - 29 Source: Experian, GVA Grimley Source: IPD, GVA Grimley change pa Rental Change during 29 () Index, October 23 = Dec-3 Jun-4 Dec-4 Jun Dec Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 City Mid Town West End South East Distribution Standard UK Regional Warehouses Shops Central London Regional UK High Street Retail UK Industrials Index, 28 = Index, October 23 = 1 Rental Index - Last Five Years Dec-3 Jun-4 Dec-4 Jun Dec Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Central London Regional UK High Street Retail UK Industrials Index, 28 = Rental change, years to March 29 () Prime rental change, last years to March 29 - West End Rental Change - Main Property Sectors Actual Forecast -year review period Fitzrovia 22 Holborn Mayfair 2 26 North 27 of Paddington Soho St James's Victoria Retail Headline Industrial Net Effective C Rental change, years to March 29 () Prime rental change, last years to March 29 - West End Fitzrovia Holborn Mayfair North of Paddington Soho St James's Victoria Rental change, years to March 29 () Prime rental change, last years to March 29 - City / Average Rents - forecast change over previous years Dec Central 8 ChanceryMar City 9Eastern City Northern Jun-9Insurance West Sep-9 City Southwark Canary Dec-9 Wharf Other City Core Lane/ Fringe Fringe Sector Midtown Standard Shops Standard Headline s Distribution Net Effective Warehouses Prime rental change, last years to March 29 - City / Average office rents - forecast change over previous years arch 29 () GVA Grimley Ltd 1 Stratton Street London W1J 8JR 3

4 Rent Review Outlook Spring 29 Central London office rental trends The central London office market in particular has seen a significant variation in rental growth over the last five years, as the charts opposite illustrate. These show the change in headline rents, and also the change in net effective rents, taking into account rent free periods 1, over the five years to March 29. In the majority of central London locations, rent levels are still higher than five years ago, although the increase in net effective rents has generally been lower, due to rising rent-free periods. However, there are very significant differences between submarkets. In the West End, the net effective prime rent in Paddington is higher than five years ago, suggesting that occupiers are still likely to experience a very significant rental increase at review. More typically, net effective prime rents are in the region of 2 higher than five years ago (for example Victoria and Fitzrovia). In Mayfair, the net effective prime rent is now only 11 higher, whilst in, the figure is only 6.. In the City, the picture is somewhat different, as net effective prime rents are now below their level of five years ago in the City Core, by 6. At the other extreme, net effective prime rents in Chancery Lane/Midtown are still 6 higher than five years ago. In, rental performance within the Canary Wharf estate has differed significantly from that outside it. Net effective prime rents in Canary Wharf are now only 6 higher than five years ago, whilst those outside the estate are still 83 higher, suggesting the potential for very significant rental uplifts at rent review. These rental changes are summarised in the table below. Index, Index, October O Rental Rental change, change, years to years March to March 29 () 29 () Dec-3 Jun-4 Dec-4 Jun Dec Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 9 Dec-3 Jun-4 Dec-4 Jun Central London Dec Jun-6 Regional Dec-6 Jun-7 Dec-7 UK High Street Retail Jun-8 Dec-8 UK Industrials Central London Regional UK High Street Retail UK Industrials Prime rental change, last years to March 29 - West End Prime rental change, years to March 29 West End Prime rental change, last years to March 29 - West End Fitzrovia Holborn Mayfair North of Paddington Soho St James's Victoria Fitzrovia Holborn Mayfair Headline North of Net Paddington Effective Soho St James's Victoria Prime rental change, last years to March 29 - City / Prime rental change, Prime rental years change, to last March years to 29 March 29 City - / Source: GVA Grimley 9 Rental Rental change, change, years to years March to March 29 () 29 () Central City Core Central City Core Chancery Lane/ Chancery Midtown Lane/ Midtown City Eastern Fringe City Eastern Fringe City Northern Insurance Fringe Sector City Northern Insurance West City Southwark Canary Wharf Other Fringe Sector Headline Net Effective West City Southwark Canary Wharf Other Index, Index, Change in prime net effective rents, March 24 - March 29 March 24 March 29 Prime headline Rent Net Effective Rent Prime headline Rent Net Effective Rent Change in Net Effective Rent West End Fitzrovia Holborn Mayfair North of Paddington Soho St James s Victoria City Central City Core Chancery Lane / Midtown City Eastern Fringe City Northern Fringe Insurance Sector West City Southwark Canary Wharf Other The net effective rent is calculated on the basis of a ten-year lease, adjusted for rent free periods, with a 6-month rent free as standard (and therefore deducted from the calculation). 4 GVA Grimley Ltd 1 Stratton Street London W1J 8JR

5 Rent Review Outlook Spring 29 What is the short-term outlook for commercial property rental values? So how far are rents likely to fall over the next year? The UK economy is now officially in recession for the first time since 1991, a downturn that is now widely expected to be the worst since the 193s. Forecasters are unanimous that the fall in economic output will accelerate in the first half of 29, despite very low interest rates, increased government spending and a lower valued pound, to give GDP growth of around -3. or worse in 29 as a whole. We expect high street shops to see a rental fall of around 7, as consumer spending continues to have a major impact on the sector. The retail sector has been impacted on by business failures such as Woolworths and Zavvi and this is adding considerably to available supply (although the recession is providing a boost to many discount retailers, some of whom are expanding). We expect distribution warehouses to see a similar fall in rents of around 7 this year. It is important to note that local market conditions may vary considerably from these market averages. Although the current development cycle has not been as pronounced as that preceding the early 199s property crash, there has been a considerable amount of speculative development activity in the central London office market, some regional office centres, and a significant number of major shopping centres have also been constructed over the last two to three years. Construction is now being almost universally put on hold, due to a combination of weak occupier demand and a lack of viability, so eventually excess supply will be used up, but this will take several years in some markets. Clearly, weak demand and rising supply will have a significant impact on the commercial property occupier market, and a further fall in rental values is inevitable. Although we expect average rental values to fall across the commercial property sector, the magnitude will vary according to sector and location. The impact on commercial property rents throughout 29 will be very marked, as the chart below suggests. We expect average All Property rental values to fall by close to 11 during the whole of 29. However, there is a clear split between central London offices, and much of the rest of the commercial property sector. Average rental growth forecasts 29 Average Rental Growth Forecasts - 29 Source: Experian, GVA Grimley All Property - over rented, reversionary or void? Source: IPD Quarterly Index Rental Change during 29 () City Mid Town West End South East Distribution Warehouses Standard UK Shops Regional 1 Q4 Q1 Q2 Q3 Q ials Dec-8 Rental Change - Main Property Sectors In central 11 Actual Forecast London, we forecast falls in average office rents of 2 or more this year, as the turmoil within the financial services sector 1 and the fall in office demand across the wider economy mean 9 that occupier demand is evaporating just as a raft of office development 9 schemes finish construction. Index, 28 = 1 8 s 8 in the South East are forecast to see a much lower fall -year review period in average 7 rents of around 9, whilst the regional markets are forecast 7 to see a fall of around 6. However, the picture across the UK s 6 main regional office centres is mixed, with several city centre 6 markets having seen a significant amount of development activity in recent years, whilst others have a much more constrained supply. Central London s - over rented, reversionary or void? Source: IPD Quarterly Index Q4 Q1 Q2 Q3 Q Average Rents - forecast change over previous years 2 1 GVA Grimley Ltd 1 Stratton Street London W1J 8JR

6 7 Rent Review Outlook Spring 29 How will past rental performance and the expected Prime rental change, last years to March 29 - West End change affect reviews over the next year? What can occupiers and landlords expect at rent reviews during 6 29? Our analysis Average looks Rental at Growth the Forecasts change - 29 Source: in average Experian, GVA rental Grimley values over the last five years and the expected future change using our 4 forecasts for rental growth. 3 Of course, every building and location is unique, and the analysis 3 here -1can only provide a broad guide. The actual change will 2 depend on a wide variety of factors based on the specific building, 2 - its location, 1 and the conditions in the local market. Rental Change during 29 () Index, Index, October O -2 Rental Rental change, change, years to years March to March 29 () 29 () Dec-3 Jun-4 Dec-4 Jun Dec Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 9 Dec-3 Jun-4 Dec-4 Jun Central London Dec Jun-6 Regional Dec-6 Jun-7 Dec-7 UK High Street Retail Jun-8 Dec-8 UK Industrials The chart below shows Fitzrovia Holborn how average Mayfair North rents of Paddington have moved Soho St in James's the Victoria three -2 main commercial Fitzrovia Holborn property Mayfair sectors since 1998, together with Headline North of Net Paddington Effective Soho St James's Victoria the forecast change over the next five years. This clearly illustrates -3 the cyclical City nature Prime Mid Town of rental the change, West market, End last years South to most March East 29 notably Distribution - City / in Standard the Source: UK office Regional GVA Grimley sector Warehouses Shops (due to the effect of central London). 9 Central London Regional UK High Street Retail UK Industrials Prime rental change, last years to March 29 - West End Prime rental change, last years to March 29 - City / Index, Index, year review period Rents - expected change over previous years Source: IPD, Experian, GVA Grimley 2 Average Rents - forecast change over previous years All Property - over rented, reversionary or void? Source: IPD Quarterly Index Dec 8 Mar 9 Jun-9 Sep-9 Dec-9 Dec 8 Mar 9 Jun-9 Sep-9 Dec-9 Standard Shops Standard s Distribution Warehouses 1 6 Q4 Average Q1 office rents - forecast Q2 change over previous Q3 years Q year review period Average Rents - forecast change over previous years Standard Shops Standard s Distribution Warehouses rents - expected change over previous years Source: IPD, Experian, GVA Grimley Over Average Rented office (lhs) rents - forecast Void (lhs) change over previous Reversionary years (rhs) 8 7 Tenancies Dec-8 als Rental change main property sectors Index, 28 = 1 Rental Rental change, change, years to years March to March 29 () 29 () Rental Change - Main Property Sectors year review period 7 City Core Lane/ Fringe Fringe -1 Central Chancery City Eastern City Northern Insurance Sector West City Southwark Canary Wharf Other -1-2 Central Chancery Midtown City Eastern City Northern Insurance West City Southwark Canary Wharf Other 7 City Core Lane/ Fringe Fringe Sector -2 Midtown Actual Source: IPD, Experian, GVA Grimley Forecast 1 4 Central London s - over rented, reversionary or void? Source: IPD Quarterly Index Dec 8 Mar 9 Jun-9 Sep-9 Dec-9 Dec 8 Mar 9 Jun-9 Sep-9 City Mid Town West End South East s Regional s Dec-9 City Mid Town West End South East s Regional s 6 Q4 Q1 Q2 Q3 Q Change in average rents over the previous five years 8 7 Average Rents - forecast change over previous years Our 2 analysis suggests that there will be a rapid change during 29 in the difference between prevailing rental values and the values from five years previously. This is because rents were rising during the period 24 to 27 (most notably in the retail sector, 1 although offices and industrials were also seeing some growth), but we are forecasting some considerable falls in rental values in 29, 21 and 211, as illustrated in the chart above. March 29 March 21 UK Standard Shops 7-3 City 6-19 Mid Town West End 32-4 South East 2-6 oria The table opposite sets out the change that has occurred over the last five years, and the change that we would expect to have occurred Dec in 8rental values Mar 9 over the Jun-9 five-year period Sep-9 to March Dec-9 21, using -1 a combination of actual IPD historical data and our property Standard Shops Standard s Distribution Warehouses market forecasts. By March 21 growth is negative and the change at rent review would therefore be zero. Regional 6-1 Distribution 1-7 Warehouses Source: IPD Quarterly Index, Experian, GVA Grimley Average office rents - forecast change over previous years Clearly, the next 12 months are likely to see the overall market moving from a position where an uplift is likely to occur at rent review, 4 to one where a nil or nominal uplift is likely to be the norm. We must stress that these figures provide a guide to what 3 occupiers and landlords can expect, based on IPD data. Individual locations 2 will have their own specific factors which will affect this. 1-1 ther cklands -2 Dec 8 Mar 9 Jun-9 Sep-9 Dec-9 City Mid Town West End South East s Regional s 6 GVA Grimley Ltd 1 Stratton Street London W1J 8JR

7 27 s n-8 Dec-8 Industrials rimley Victoria nal harf Other 213 Rent Review City Outlook Mid Town Spring West End 29 What proportion of property leases are reversionary Rental Change - Main Property Sectors versus over-rented or not income-producing, and 11 Actual Forecast how is this changing? Changing 1 market conditions are now impacting on the market in terms of 9 the proportion of leases that are reversionary (where the open market 9 rental value is above the rent passing), versus those that are over-rented 8 (where the open market rental value is below the rent passing) 8 or void (i.e. not -year income review period producing). IPD data 7(from the Quarterly Index) shows that the proportion of all leases 6within the database that are reversionary fell gradually during the 6 first three quarters of 28, from 71.3 at the end of Q4 28 to.7 at the end of Q3 28. Quarter 4 saw a much more significant decrease, to 6. The proportion of over rented properties increased gradually from 17.1 of properties Average Rents - forecast change over previous years in Q4 27 to 18. in Q3, followed by a much steeper increase 2 in Q4 to The proportion of properties that are void has also risen over the period, from 11.6 in Q4 27 to 13.8 in Q This demonstrates that market conditions are already having a direct impact on landlords, with the proportion of leases where rents will increase at review falling, and the proportion where no income is being generated rising. All property - over rented, reversionary or void All Property - over rented, reversionary or void? Source: IPD Quarterly Index Dec 8 Mar 9 Jun-9 Sep-9 Dec Q4 Q1 Q2 Q3 Q Central London s - over rented, reversionary or void? Source: IPD Quarterly Index Dec 8 Mar 9 Jun-9 Sep-9 Dec-9 8 The largest shift has occurred City Mid Townin West the End central South East London s Regional office smarket, where Q4 28 saw a very marked increase in the percentage of 2 tenancies that are over rented from 12.2 in Q3 to 2.7 in Q4. There was a corresponding marked decrease in reversionary properties, from 73.8 of all tenancies in Q3 to 63.7 in 7 Q4. Void 1rates also saw an increase, and this is likely to accelerate, as the central London vacancy rate is now rising rapidly. Indeed, our analysis shows that available space rose from.7 of the total stock at the end of Q3 28 to 6.8 at the end of Q4. Rental Chan Index, 28 = South East Distribution Warehouses Standard Shops Standard s Distribution Warehouses Average office rents - forecast change over previous years 6 Q4 Q1 Q2 Q3 Q Standard UK Shops Regional Source: IPD 8 7 Tenancies Q4 Q1 Q2 Q3 Q High street shops have seen a similar trend, although the changes have been somewhat less marked. Again, we would expect this trend to continue over the coming quarters. Interestingly, the distribution warehouses sector has not yet seen any change in the percentage of over-rented properties. What is the long-term outlook for rental values and inflation? Over the last five years to February 29, the RPI index has increased by and the CPI index by Commercial property has, on average, increased at a slightly lower rate than this over the same period, with the All Property figure from IPD at 8.6 (Monthly Index), although as we have seen, different sectors and locations will have performed very differently from the All Property average. The story over the next five years will be very different. With economic output likely to continue falling into 21, followed by 2-3 years of below trend growth, commercial property rents are likely to continue to fall for some time. Following an expected fall in All Property rental values (in nominal terms) of around 11 this year, we forecast a drop of 8 in 21 and of 4 in 211. In other words, we expect rental values to be more than 2 lower at the end of 211 than that the end of 28 (and around 2 lower in real terms). We expect the rate of RPI inflation to become negative in 29 (in other words, deflation), as economic output continues to fall. Unlike commercial property rents, inflation is likely to increase markedly in 21, with a risk that it will rise above the Bank of England s target of 1-3 for CPI. In the medium term, however, we expect inflation to return to a little above the Bank of England s target of 2 (CPI). The following table summarises our latest forecasts for inflation and commercial property rents over the next five years. Summary of forecasts RPI, CPI, All Property Rents () RPI CPI IPD Annual Index Source: Experian, GVA Grimley Central London - over rented, reversionary or void Central London s - over rented, reversionary or void? Source: IPD Quarterly Index 6 Q4 Q1 Q2 Q3 Q ry Source: IPD 9 GVA Grimley Ltd 1 Stratton Street London W1J 8JR 7

8 For advice and further information, please contact us: Duncan Locke, National Head of Lease Consultancy duncan.locke@gvagrimley.co.uk Roger Lown, Director, Lease Consultancy roger.lown@gvagrimley.co.uk Stuart Morley, Head of Research stuart.morley@gvagrimley.co.uk London West End Belfast Bristol Edinburgh Leeds Newcastle 1 Stratton Street London W1J 8JR Rose Building Third Floor 16 Howard Street Belfast BT1 6PA St Catherine s Court Berkeley Place Bristol BS8 1BQ Quayside House 127 Fountainbridge Edinburgh EH3 9QG First Floor, City Point 29 King Street Leeds LS1 2HL Yorkshire Chambers 112/118 Pilgrim Street Newcastle upon Tyne NE1 6LL London City Birmingham Cardiff Glasgow Liverpool Manchester 8 Cheapside London EC2V 6EE 3 Brindleyplace Birmingham B1 2JB One Kingsway Cardiff CF1 3AN 26 St Vincent Street Glasgow G2 SG Mercury Court Tithebarn Street Liverpool L2 2QP 81 Fountain Street Manchester M2 2EE Published by GVA Grimley Ltd 1 Stratton Street, London W1J 8JR copyright GVA Grimley Ltd GVA Grimley Limited is a principal shareholder of GVA Worldwide, an independent partnership of property advisers operating globally