Upturn in commercial property may have run its course

Published 12th Jul 2010

• Office rents in the first and second quarters were 12% higher
• Boom that delivered 14% capital growth is slowing, IPD says


Last summer Nomura's decision to move to new headquarters in London's One Angel Lane beside Cannon Street station was hailed as signalling a turnaround in the City property market, which had been hammered by the credit crunch. It is the largest deal on a new office building in London to date. But as the Japanese investment bank starts to move all its staff to the new building at Watermark Place today, questions are being asked about the sustainability of the pick-up.

This year two big deals followed in the Square Mile: fund manager BlackRock snapped up 292,000 square feet of prime office space in Drapers Gardens. It agreed to a 25-year lease at a rent of £49 a square foot, with a rent-free period of three years – which compares with Nomura's six years. And Australian investment bank Macquarie took more than a third of British Land's 595,000 sq ft Ropemaker Place.

At the time, analysts at Cazenove said BlackRock in effect gazumped Macquarie, which had reportedly agreed to lease Drapers Gardens for 20 years at £43 a square foot, with a four-year rent-free period. It was a sign that the pendulum was swinging back towards landlords, who were forced to agree long rent-free periods during the property slump.
Foreign money

However, despite an influx of foreign money into the City, with investors taking advantage of the weak pound, growth in property values has started to tail off, according to IPD data. It could turn negative soon – only three years since the market peaked in June 2007, before the onset of the financial crisis.

"The 10-month rally in prices since last August, which has seen 14% capital growth, seems to be running out of steam," according to IPD's Phil Tily, director of UK client reporting. "Should capital growth reverse, the focus will turn to how to stimulate a long-term, sustainable rental recovery as income is the long-term driver of commercial property returns for investors."

The latest monthly index from real estate adviser CB Richard Ellis also showed growth in commercial property prices slowing for a third month, to 0.6% in June. "The property investment market is clearly slowing, with investors turning more cautious and yields flattening. Outside central London, occupier markets remain fragile," said CBRE analyst Nick Parker.

London office rents are still recovering strongly, however, as numerous surveys have shown. A report out today from NB Real Estate, part of the Capita Group, says average rents for prime office space in the City have jumped to £53 a square foot in the second quarter, from £47.50 a year ago. Rents have risen by nearly 12% in the first and second quarters.

James Gillett, director of City Offices at NB Real Estate, says: "Two successive quarters of such strong rental growth is without precedent. It underlines just what a rollercoaster ride the commercial property market and the City has been on during the last two years. Often the harder a market falls, the stronger it bounces back. Rents fell off a cliff post Lehman Brothers. We are now seeing them rebound strongly as demand from occupiers recovers and the supply of prime office space dries up."

According to commercial property consultants Cushman & Wakefield, office space leased so far this year has more than doubled compared with last year, when the market hit a low point.

But James Young, head of Cushman & Wakefield's City office, cautioned that the second quarter had been quieter than the first, as tenants took stock of the new coalition government and its austerity measures. The recovery is not going to be smooth. Land Securities' chief executive Francis Salway, for instance, is expecting "ripples" in the market in the next few years. Growth in office rents is mainly driven by the lack of suitable space, rather than a big pick-up in demand. "It's no surprise given that the development pipeline over the last two years had been switched off," said Young. "New development is quite thin on the ground. Developers are still being very selective about making decisions on real estate." He expects City rents to rise to £60-plus a square foot in the next two years, saying they could even go beyond the pre-crisis levels of £65.

Last week property tycoon Gerald Ronson secured his first tenant for the Heron Tower. He signed up law firm McDermott Will & Emery to take up two floors at a rent of about £55 a square foot – the highest since the recession.


New boom

The London office market is heading for a new boom in the next five years when a large number of leases expire, fuelling demand for new office space. There is not enough new space being built to satisfy this surge in demand. Two of the biggest projects are British Land's 122 Leadenhall Street – known as the Cheese Grater – and Land Securities' 20 Fenchurch Street – the Walkie Talkie.

What helped mitigate the property slump was that developers learned their lessons from the previous recession and did not flood the market with speculative development. Voids for prime central London offices were below 4% in the last two years, compared with voids of 19% in the early 1990s.

There is still little speculative development, and a return of pre-lets. Pre-letting property reduces the risk for developers, while occupiers can request modifications to the buildings early on to suit their needs. Funding is another important factor: at the moment it is well nigh impossible to secure finance from lenders for speculative projects. "The developer almost has to pre-let the building in some form to get funding," said Young.

More cranes have reappeared on the London skyline as developers are cranking up schemes that were put on hold during the worst recession in decades.

"A lot of developers are dusting down their files, looking at funding and the shortage of office supply over the next three to four years," said Alistair Brown, a director at DTZ' City office.

However, it takes several years to get planning permission and erect a building. Another problem faced by developers is that it is harder than usual to second guess what sort of space will be in demand in a few years' time. If banks are forced to separate deposit taking from their riskier investment banking activities, "they will require a different formatting of space," noted Mike Prew, head of real estate research at Nomura. "Developers are trying to guess the shape of a very complex banking industry in the immediate aftermath of the banking crisis and with an uncertain political outlook."

Across the country, office markets in places such as Cambridge are also showing the first signs of a turnaround, but will take much longer to recover than the London market.

The British Property Federation believes speculative development is crucial to kickstarting the property market and driving down office rents for small firms. However, one of the obstacles is the government's removal of tax relief on empty non-domestic buildings in 2008. Empty rates relief was introduced in 1989 in response to an ailing property market.

Liz Peace, chief executive of the British Property Federation, said: "With the false economy we have in prime London offices, the real question is how will the rest of the country recover. Despite calling it 'wicked' and 'ungodly' [Michael Gove in 2009] the Tories are keeping Labour's empty rates tax which is choking off any hope of new speculative development. They should look to waive empty rates on newly built space at the very least – a signal of support for business that wouldn't cost them a penny."

Source: ' Guardian '

View All Latest News