City Commentary
Tom Boggis
Director
Equipe Real Estate Advisors
Hold on tight…
Whilst it was not surprising that the credit crunch and banking crisis had a dramatic effect on the City of London office market, two years later, the market remains volatile. At the beginning of the year, the market appeared to have had one of its best quarters ever and then take-up in Q2 crashed by 52% to 976,000 sq.ft. Our provisional figures now suggest that take-up has bounced back to c.2 million sq.ft.in the 3rd quarter which ended a few days ago.
On the face of it these swings in market activity are alarming. The City office market has generally had a reputation for volatility, however, it lacks the liquidity of a financial market, so how can we rationalise the fluctuations seen in the last 18 months?
The answer is in looking at beyond the total take-up figures at what is really going on in the market. By analysing activity by size it is possible to see that the market is not quite the "emotional rollercoaster" that the take-up figures might suggest. Our "Cappuccino" analysis, see chart, grades market take-up according to size band and gives a clearer impression of what the market is actually doing.
The chart enables one to see where the peaks and troughs occur and therefore whilst on the face of it a 52% decline in total take up in Q2 2010, followed by a swing back of 55% looks alarming, this only reflects a hiatus in large deals taking place. These deals tend to disproportionately skew market statistics. For example, in the previous 12 months 2.5% of deals by number accounted for 41% of total take-up. The 700,000 sq.ft. dark brown band of take-up at the top on the Q3 bar in the chart, actually represents only one deal – UBS's deal in Broadgate.
Very large deals also tend to be as a result of long term strategic corporate decisions and therefore their timing is not necessarily indicative of, or influenced by, day to day market conditions. The rest of the market shows less volatility. The chart shows that activity in the 50,000-100,000 sq.ft bounced back in the quarter and that the activity below 50,000 sq.ft. has remained fairly robust for the last year.
To an extent one can explain the dip in Q2 activity as being due to the General Election, but whilst these trends are encouraging the market still faces several challenges – lack of supply, particularly of grade A stock and that the general level of activity has still not recovered to pre-credit crunch levels.
At the end of June, most commentators estimated that availability had reduced to c.6.2 million sq.ft., 30% lower than this time last year. Grade A new stock was estimated as being down to 2.6 million sq.ft. and by now, this will have reduced further. 61% of take-up in Q2 was in new or refurbished space and as the availability of Grade A space dwindles further, rents for the best space will continue to rise. Prime rents are now c.£50-52.50 psf. – up £10 psf on a year ago. This is bad news for occupiers who are looking to move, re-gear their leases or negotiate rent reviews.
Prima facie a tightening of the market is good news for landlords, or those looking to lease surplus space. However, whilst activity has improved, the average quarterly take-up level for deals smaller than 50,000 sq.ft. in the last 12 months remains 23% lower than the average in the 2 years prior to the credit crunch. The Market for secondary space also remains in the doldrums. To date there has been no reflection of the impact of the Government's spending cuts on the market. Therefore, as encouraging as the above is, one can only conclude that we should continue to hold on tight….we are still in for a bumpy ride.