Property Times Central London Q3 21 Supply shortage looms in 211 19 October 21 Contents Executive Summary 1 2 Overview 2 Maps 3 City West End Mid Town Emerging Markets 7 Key Statistics 8 2 Major Transactions 8 Investment 9 Definitions 11 Contacts 12 Take up recovered strongly in Q3, rising 3.7 million sq ft from 2.8 million in Q2, bringing the Q1-3 total to just shy of 11 million sq ft. Take up for the year as a whole looks likely, if the Bloomberg deal transacts, to reach 1 million sq ft. This was the total in 27 and level with long term average take up for the market. Demand is steady rather than spectacular, but is taking place at a juncture when speculative development deliveries are declining. Completions in 211 will total 2 million sq ft, only a third of the long term average over the last 2 years. This shortfall in supply was caused by a very strong decline in development starts in the aftermath of the financial crisis in 28. Since the Lehman collapse in Q3 28 only 2.8 million sq ft has been started, compared with nearly 13 million sq ft in the same 2 year period immediately before that point. Author Martin Davis Head of UK Research + ()2 329 23 martin.davis@dtz.com Contacts Strong demand for grade A space in the face of declining supply will continue to support prime rental growth. DTZ forecasts end year rents of per sq ft and 8 per sq ft in the City and West End respectively, growing to and 9 per sq ft in 211. Investment transactions in Q3 increased nearly a third, from 2.2bn in Q2 to 2.9bn, the highest level since Q2 28 and above the 1-year average. Tony McGough Global Head of Forecasting & Strategy Research + ()2 329 231 tony.mcgough@dtz.com Hans Vrensen Global Head of Research + ()2 329 219 hans.vrensen@dtz.com Figure 1: Central London development starts Sq Ft 3, 2, 2, 1, 1, 27.1 27.3 28.1 28.3 29.1 29.3 21.1 21.3 City West End Rest of Central London www.dtz.com 1
Overview The UK economy is likely to grow by a sub-trend 1.2% in 21, and London s growth in output, according to Oxford Economics, will be a slender.%. Financial and business services are expected to fare better, with output growth of 3% (stronger for business services), translating into F&BS employment growth of 2.%. level notwithstanding, take up will not fade away significantly into 211. Figure 3 Central London speculative construction starts Sq Ft 3, This is now being felt in the office occupier market. Confidence has to some extent returned and is being reflected in take up of space. The Q3 total, 3.7m sq ft, boosted by the 7, sq ft prelet to UBS at Broadgate, brings the year-to-date total to just under 11m sq ft (Figure 2). If Bloomberg s, sq ft Walbrook Square deal, currently under offer, goes through in Q, take up for year will reach around 1m sq ft. This will be similar to the 27 total and around the long term annual average take up for the market. Availability is not falling at the swift rate of late 29. It declined by 3.% in Q3 to 17m sq ft, an availability ratio of 7.3% (Figure ). This is still above the longterm trend. Newly built or refurbished space availability is also quite substantial, now at.2m sq ft, but has declined % since its peak in mid 29. Figure 2 Central London take-up & prime rents 7 3 2 1 Q3 27 Q1 28 Q3 28 Q1 29 Q3 29 Q1 21 Q3 21 Grade A Grade B Grade C City prime rent West End prime rent Mid Town prime rent Rent ( /sq ft) The level of under offers fell by 2% to 2.8m sq ft, in major part because the UBS deal transacted. The current level is a reversal of the upwards trend since Q1 29 and, if this continues, take up in the New Year may weaken from its current level. The level of upcoming demand, as indicated by known requirements, is now somewhat down from the 9.m sq ft of Q 29, but is still at the long-term level of 7.m sq ft. This suggests that the under offer 12 1 8 2 2, 2, 1, 1, 27.1 27.3 28.1 28.3 29.1 29.3 21.1 21.3 City West End Rest of Central London Demand is steady and unspectacular, but speculative development deliveries on the other hand are not expected to be strong (Figure ). In fact, delivery of space in 211 will total 2m sq ft, only a third of the long term average annual level of completions into the Central London market over the last 2 years. This current shortfall in new supply was caused by a very strong decline in development starts in the aftermath of the financial crisis in 28 (Figure 3). Since the Lehman collapse in Q3 28 only 2.8m sq ft has been started, comprising only 7, sq ft in the City, twice this volume in the West End, and little else elsewhere in Central London other than the Shard at London Bridge. This contrasts with nearly 13m sq ft started in the same 2 year period immediately before the Lehman collapse. Within take up absorption of grade A space is strong, and in the face of declining supply will continue to support prime rental growth in Central London. This has taken effect in the City and Midtown markets, and rents are starting to increase in the West End. DTZ forecasts end year rents of per sq ft and 8 per sq ft in the City and West End respectively, growing to and 9 per sq ft in 211. Investment transactions increased 32% from 2.2bn in Q2 to 2.9bn in Q3 and exceeded the 1-year average level of 2.bn. Q3 transactions were dominated by the sale of the Thames Portfolio which, with of its buildings in Central London, was sold to Carlyle for 71m, comprising 21% of the Q3 transactions. www.dtz.com 2
Overview Figure : Central London stock and availability by sub market area Office stock (s sq ft) 88, 3, North.% 7, xx% Occupied Available Availability ratio City 8.7% West 7.3% West End.% Mid Town.% East 9.1% South.1% Docklands 7.1% Source : DTZ Research, Navteq 1 2 km Figure : Central London development under construction Development Pipeline Q3 21: Net sq ft Under Construction, 12, 3, Completion year Mid Town City 21 211 212-21 West End Source : DTZ Research, Navteq Note: symbols refer to specific development schemes 1 2 km www.dtz.com 3
City In the City availability rose by 12, sq ft in Q3. After falling for 9 months, the availability ratio in the City has remained fairly static during 21, hovering between 8-9%, as the supply of newly developed space remained strong, despite rising take up. Take up has recovered its momentum of Q1: Q3 doubled Q2 s total to reach to 1.9 million sq ft (Figure ). To date (Q1-3) take up has totalled.1 million sq ft and we estimate that the annual total will reach over. million sq ft in 21 if the Bloomberg preletting goes through. This compares with. million sq ft in 29 and 3.8 million sq ft in 28, and will be well above the 2 year take up average of. million sq ft. The high level of financial sector take up in 21 (9% verse a long term average of 2%) was even higher (71%) in Q3 due to the preletting of 7, sq ft at Broadgate to UBS. Figure City office take-up & availability ratio 2. 2. 1. 1... Q3 28 Q 28 Q1 29 Q2 29 Q3 29 Q 29 Q1 21 Q2 21 Q3 21 Grade A Grade B Grade C Availability Ratio Figure 7 % 1 12 1 8 2 Active demand (known requirements) has remained at a similar level in recent months, at about million sq ft, but still substantially above the 1 year average of. million sq ft. The insurance, banking and legal sectors have become more important compared to a year ago, with live requirements from occupiers such as AON, Schroders and Cameron McKenna. Apart from the recent commencement of the internal refurbishment of 1, sq ft at 3 Waterhouse Square, EC1 to Grade A standard, no other significant development has started construction this year in the City, its Fringes or Docklands. This reinforces the prospect that 212 development deliveries will be even weaker than those of 211 (Figure 7). City office new development. 3. 3. 2. 2. 1. 1... 2 2 27 28 29 21 211 212 Historic development Speculative Speculative Forecast Pre-let Nevertheless, DTZ anticipates substantial starts going forward as there are a number of schemes positioned to progress. However, finance is still an issue. Currently most schemes are being marketed for preletting, although as the certainty of undersupply builds someone is likely to break ranks soon. Figure 8 City prime headline office rents psf 8 7 Months 3 Rental growth continued in Q3, moving up to 2. per sq ft, while incentives remained static at 2 months rent free on a 1 year lease. Further movement is expected by year end, with rents rising to per sq ft and incentives falling to 21 months. 3 2 3 2 2 1 1 Due to undersupply rental growth is expected to continue to be strong in 211 (Figure 8), rising to per sq ft. Thereafter rents are expected to rise more slowly, due to a stabilisation in demand combined with a gradual increase in development activity. 1 Note: On a 1 year term City headline rent Rent free period (RHS) www.dtz.com
West End Availability remained broadly static in the West End in Q3, at 3.9m sq ft, an availability ratio of.% (Figure 9). New availability continued to shrink, ending at 8, sq ft, half of its Q2 29 level. Although second hand availability rose to offset this, a major component of this growth, two government buildings in Victoria (Abel and Cleland House), are now reported as under offer for redevelopment as residential. The level of under offer space remained stable at 3, sq ft, while take up totalled 7, sq ft, similar to the Q2 level and close to the long term average (8, sq ft). New space absorption has averaged 2, sq ft over the last five quarters: and current availability amounts to less than a year s demand at this rate. Figure 9 West End office take-up & availability ratio %.8.7....3.2.1. Q3 28 Q 28 Q1 29 Q2 29 Q3 29 Q 29 Q1 21 Q2 21 Q3 21 Grade A Grade B Grade C Availability Ratio 9 8 7 3 2 1 Financial occupiers again took the largest share of take-up by business sector in Q3. In fact the sector has consistently taken more than 2% of floorspace in the first nine months of 21. This echoes the importance of financial sector take up in the boom years of 23-7. Figure 1 West End office new supply 2. The development activity of Q2 (79, sq ft), has not been sustained in Q3 nothing was started. One building was delivered; 1 Grafton Street (2,7 sq ft). This will be followed by two small buildings totalling 2, sq ft in Q, making speculative delivery in 21 a mere 129, sq ft (Figure 1). This is a very constrained supply when compared with the long term average of around 9, sq ft. 1.8 1. 1. 1.2 1..8...2 Although speculative deliveries will increase in 211 to 23, sq ft, in nine developments, this is still very much below the long term average (9, sq ft). A substantial supply response, totalling around 9, sq ft, will not arrive until 212. Four large schemes totalling 78, sq ft, are already committed, and will be supplemented by several other developments likely to proceed in the near future.. Figure 11 2 2 27 28 29 21 211 212 Historic development Speculative Speculative Forecast Pre-let West End prime headline office rents psf 12 Months 3 Shortage of development supply, when combined with an average level of demand such as pertains currently, will cause upward pressure on rents. And indeed prime headline rents are beginning to move upwards, having reached 82. per sq ft in Q3. 1 8 2 2 1 1 Now incentives are moving in, DTZ expects further rental growth to take place in the remainder of the year, accelerating as the shortage of prime stock intensifies. Thus DTZ forecast prime headline rents to reach 8 per sq ft by end 21, growing to 9 per sq ft by end 211 (Figure 11). 2 Note: On a 1 year term West End headline rent Rent free period (RHS) www.dtz.com
Mid Town Unlike other core markets availability in Mid Town continued to rise until Q1 21, but has now declined substantially. At the end of Q3 it was.% of stock, shrinking by 23, sq ft, reducing new space by 17, sq ft to, sq ft (Figure 12). New and good quality space declined, while poor quality floorspace was augmented by the marketing of 8, sq ft at Boro House, Lincoln s Inn Fields, for sale with vacant possession. Figure 12 Mid Town take up and availability ratio.3.3.2.2 % 8 7 Take up increased for a fifth consecutive quarter in Q3, and in 21 so far it has averaged 33, sq ft per quarter, which is the long term average. The level of under offer space has increased by two thirds in Q3 to around, sq ft, mainly newly built and poor second hand space. This suggests that there will be a substantial increase in take up in Q..1.1.. Q3 28 Q 28 Q1 29 Q2 29 Q3 29 Q 29 Q1 21 Q2 21 Q3 21 Grade A Grade B Grade C Availability Ratio 3 2 1 There is only one scheduled completion in 211; 1 Kingsway, totalling 1, sq ft (Figure 13), while the remaining potential scheme, a refurbishment at 33 Kingsway, has still not yet started. As in other submarkets, the timing for delivery of any substantial developments in 212 is also getting tight. In particular Chichester House, High Holborn, and Lonsdale House, Chancery Lane, are two significant developments which could deliver a total of 1, sq ft in 212, but in order to do so must be started before the end of the year. Figure 13 Mid Town development pipeline....3 The highest achieved rent of the quarter was 8 per sq ft at Whittington House, Alfred Place, a good quality second hand building. This supports the estimation that this quarter s prime headline rent in Mid Town (Holborn) rose to per sq ft. Incentives at the end of Q3 remained at the Q2 level of 2 months rent free on a 1 year lease term. We anticipate that a supply demand imbalance, particularly in Holborn, will be the primary driver in pushing up prime headline rental values. The DTZ view is that rents will rise to 2. per sq ft in 21 (from 1 per sq ft at the end of 29) and will continue to rise (albeit at a reducing rate) between 211 and 213 (Figure 1)..2.1. 2 2 27 28 29 21 211 212 Historic development Speculative Speculative Forecast Pre-let Figure 1 Mid Town (Holborn) prime headline rents psf 7 3 2 1 Note: On a 1 year term Mid Town headline rent www.dtz.com
Emerging Markets Availability fell in all markets outside the core in Q3 (Figure 1). It fell by 3, sq ft in Docklands in Q3, causing the availability ratio to drop to 7.1% from 8.% in Q2. This was caused principally by the withdrawal by Bank of America of its available space in Canada Square, either for retention for its own use or for surrender to Credit Suisse. This is a significant move, reflecting recovering confidence by the large investment banks, which bodes well for the Docklands market. Fringe South East availability fell by 92, sq ft in Q3, reducing the availability ratio to.%. Looking more closely E1 availability fell for the fifth consecutive quarter in Q3 and is now less than half its Q2 29 peak, but continues to have one of the highest availability rates of any emerging submarket (9.1%). In Southwark availability is much lower (.1%) but has actually grown since late 29, over a period when it has fallen in most other submarkets. Fringe North West availability has been falling steeply and lost 179, sq ft in Q3, the third consecutive quarter fall. At 8.7% of stock the availability ratio is still above the Central London average, but take-up in 21 to date has been noticeably more buoyant than in 29, being already 183% up on the 29 total year figure. Notable lettings in Q3 included several lettings at British Land s 2 Triton Street, NW1, where Lendlease, Ricoh and Dimensional Fund Advisors took a total of 13, sq ft, leaving only 1, sq ft remaining in the two building development. Close by, at Paddington, W2, 97, sq ft and 1, sq ft remain available in Carmine House and 2 Kingdom Street respectively. Progress continues apace at the Shard, London Bridge, SE1, the only speculative development currently under construction in the Docklands and Fringe markets. The building is scheduled for completion in mid-212, and will be the next major speculative office building completion in the City and its fringes after that of Hines Cannon Place, EC in late 211. The prospect for a rival building (newly built speculative over 1, sq ft) becoming available in 212 seems increasingly unlikely. Prime rents in most fringe areas remained stable in Q3 (Figure 1). Canary Wharf remained at 37. per sq ft, with 27 months rent free, compared with 2 per sq ft in the wider Docklands market. The lettings at Triton Street, understood to be in the low s per sq ft, suggest that fringe West End rents have grown significantly in recent quarters. Figure 1 Emerging Markets take up and availability ratio 3. 2. 2. 1. 1... Q3 28 Q 28 Q1 29 Q2 29 Q3 29 Q 29 Q1 21 Q2 21 Q3 21 Figure 1 Emerging markets prime headline rents Per Sq Ft 3 3 2 2 Grade A Grade B Grade C Availability Ratio Southwark Docklands Canary Wharf % 1 9 8 7 3 2 1 www.dtz.com 7
Key statistics occupier market Table 1 Occupier market (million sq ft) Q3 29 Q 29 Q1 21 Q2 21 Q3 21 Q/Q change (%) Y/Y change (%) Directional outlook Central London Take-up 2.8 3.. 2.8 3.7 32% 32% Availability 21. 19.3 18.2 17. 17. -3% -19% Availability ratio (%) 9.2 8. 7.8 7. 7.3 -% -21% New supply 1.9 1.2.9 1.2 1.1-8% -2% City Take-up 1. 1. 2.3.9 1.9 111% 27% Availability 9.2 8.1 7.3 7. 7. 1% -17% Availability ratio (%) 1. 9. 8. 8. 8.7 1% -18% New supply..7.3.. % % Prime rents ( per sq ft) 2. 3. 7.. 2. % 2% West End Take-up..7.7.8.7-13% 17% Availability...2 3.9 3.9 % -22% Availability ratio (%) 8. 7. 7.1.. 2% -22% New supply..2.1.1 na -7% Prime rents ( per sq ft ) 8. 8. 8. 8. 82. 3% 3% Table 2 Key leasing transactions Address Submarket Size (sq ft) Rent (sq ft) Tenant Sector Broadgate, EC2 City 7,. UBS Finance 2 Triton Street, NW1 FNW 8, N/A Lendlease Real Estate Park & Garden Hse. 1-18 Finsbury Circus, EC2 City 72, 2. Bloomberg Media 11 Fetter Lane, EC City 8,. Weil Gotshal & Manges Legal 123 Buckingham Palace Road, SW1 West End 1, 3. Google IT www.dtz.com 8
Investment Investment transactions in Q3 increased nearly a third, from 2.2bn in Q2 to 2.9bn, the highest level since Q2 28 and above the 1-year average (Figure 17). Q3 transactions were dominated by the sale of the Thames Portfolio which, with five of its six buildings in Central London, was sold to Carlyle for 71m. Activity is now higher than in late 29: total volume for the first three quarters of 21 has come to.bn, similar to the total for the last 3 quarters of 29 and approximately equal to total transactions in 28. With a smaller number of deals during Q3 ( compared to in the previous quarter), average lot size has increased substantially. Even excluding the exceptionally large Thames Portfolio it rose by 38% from 3m to 7m. The Q3 lot average is the highest achieved since Q2 27 and reflects both the recovery in values, investor appetite, and an increase in willingness to lend, albeit only against the very best properties. Figure 17 Central London office investment volume Quarterly transactions ( bn) Annual transactions ( bn) 8 2 7 2 1 3 1 2 1 Quarterly transactions (LHS) Avg quarterly transactions (LHS) Moving annual transactions (RHS) Figure 18 Investments by purchaser type The division between foreign and domestic buyers is almost the same for both Q2 and Q3; around % in favour of foreign buyers. Europeans (including Germans) and North Americans were substantial buyers in this quarter, while Middle Eastern investors, who acquired 1% of volume in Q2 were not active at all in Q3 (Figure 18). UK institutions remain the most active overall, although private investors are still important in the smaller lot sizes, especially in the West End. Significantly reduced retail fund inflows (and in some cases net redemptions) means institutions are less pressured to spend than they were in late 29/early 21. That said, weight of money is still very apparent in the market. But while in the City it is expected that activity going forward is likely to be limited by lack of suitable stock, in the West End the shortage of properties for sale is easing, as owners are being encouraged by rising values to market space. This, combined with the depth of demand, gives them confidence that they will be able to successfully dispose at their asking price. Yields remained static in Q3 (Figure 19), but so far in 21 they have moved in 2 basis points in the City, and a very substantial 7 points in the West End, to.% and.% respectively. Looking forward, DTZ expects another 2 basis point movement in both markets, taking them to.2% and.2% by year end. 1% 9% 8% 7% % % % 3% 2% 1% % Domestic N.America Rest of Europe Germany Middle East International Other/Unknown Asia Pacific Figure 19 Central London office yields Prime Yield % 7. 7... 3. 3 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 2 21 21 22 22 23 23 2 2 2 2 2 2 27 27 28 28 29 29 21 21 City West End Mid Town www.dtz.com 9
Investment Table 3 Significant deals Address Submarket Purchaser Vendor Price (million) (initial yield) Thames Portfolio Central London Carlyle EREP Administrator 71. Watermark Place, EC City Oxford Properties UBS 182.8 (% share) 1 Gresham Street, EC2 City Hammerson/ Canada PPIB Union Investment Re 17. (.87%) Grand Buildings, Trafalgar Square, W1 Central Cross, Stephen Street, W1 West End Russian investor Istithmar West End Derwent London Glebe London 172. (.2%) 1. (.%) Bow Bells House, 1 Bread Street, EC2 City Constanti Real Estate Mitsuibishi Corporation/Estate Co. 1. (n/a) 8 King William Street, EC City RREEF Commerzreal 9.7 (.%) www.dtz.com 1
Definitions Definitions Availability: marketed space available to occupy within months. Availability ratio: office space currently available as a percentage of stock projected six months ahead (i.e. includes speculative completions during that period). Floorspace: floor area in sq ft adopted throughout is net internal area. Coverage is all office units over sq ft. Newly available: floorspace placed on the open market within the reporting period (i.e. last quarter), including both developments within six months of completion and units of second-hand space. Stock: the total office accommodation in the commercial and public sectors within the market area. Building grade: Grade A: newly developed or comprehensively refurbished to new standard, including sublet space in new/refurbished buildings not previously occupied; Grade B: buildings of good specification, floorplate efficiency and image usually but not exclusively ten years old or less; Grade C: remaining poorer quality stock. Speculative development: a newly developed or comprehensively refurbished building undertaken without the benefit of a secured tenant. Development start: a development in which work has started on the main contract. This usually excludes simply demolition and site clearance contracts. Development completion: a development in which the main contract has been completed, whether this be to shell and core or developer's finish. Active demand: named entities with a declared requirement for office accommodation which it wishes to satisfy within the foreseeable future. Under offer: units which a potential occupier has agreed in principle to acquire, subject to legal negotiations. Take-up: occupational transactions, including the following: (i) offices let/sold to an eventual occupier; (ii) developments pre-let/sold to an occupier; (iii) owner occupier purchase of a freehold or long leasehold. Headline rent: the rent formally agreed in the lease, not including any discounting due to incentives such as rent-free periods. Prime Rent: all rents are headline rents, and are for prime space. City rents refer to Grade A (top quartile) rents, which will be representative of a select group of core City buildings. It does not take account of prestige floors or tower buildings, which can achieve premium rents and have historically been 1% to 1% higher than the top quartile grouping. Mid Town rents refer to High Holborn. West End rents refer to Grade A (top quartile) rents, which will be representative of a select group of core West End properties with floor plates of a minimum, sq ft, air-conditioned, with raised floor either newly built or refurbished within the last years. Prime yield: the net initial yield of a Grade A building in a prime location occupied by a tenant with a first rate covenant. www.dtz.com 11
Contacts Agency John Forrester + ()2 329 22 john.forrester@dtz.com Alistair Brown + ()2 329 27 alistair.brown@dtz.com David Herzog + ()2 329 338 david.herzog@dtz.com Richard Howard + ()2 777 88 richard.h.howard@dtz.com Jonathan Huckstep + ()2 329 2 jonathan.huckstep.@dtz.com Craig Norton + ()2 777 839 craig.norton@dtz.com James Oliver + ()2 329 2 james.oliver@dtz.com Tim Plumbe + ()2 329 2 tim.plumbe@dtz.com Investment Ben Cook + ()2 329 332 ben.cook@dtz.com Martin Lay + ()2 329 221 martin.lay@dtz.com Colin Wilson + ()2 73 99 colin.wilson@dtz.com Development Andrew Lowe + ()2 329 29 andrew.lowe@dtz.com Professional Advisory Services Adam Beck + ()2 329 229 adam.beck@dtz.com Colette Williamson + ()2 73 7 colette.williamson@dtz.com www.dtz.com 12
` Disclaimer This report should not be relied upon as a basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, DTZ can take no responsibility for any damage or loss suffered as a result of any inadvertent inaccuracy within this report. Information contained herein should not, in whole or part, be published, reproduced or referred to without prior approval. Any such reproduction should be credited to DTZ. DTZ October 21 www.dtz.com