‘The worst is now behind us’ vs ‘the worst is yet to come’? If I knew the answer to these statements I would be a rich man…
At the time of writing, the General Election is behind us and two of the political parties are putting a very positive spin on a scenario that had been previously feared - although much of these fears were based upon the likelihood that there would be another General Election within a matter of months. We are now seeing austerity measures proposed by the new Government and, having thought that we were through the worst of the Banking crisis, the reality of the enormous problems of national debt are threatening to engulf the Worlds’ economies.
Add to that the fact that the World Cup always tends to slow the market down (it’s not the numbers of people going, but the number of people distracted by it). For the West End offices market, England either need to go out in the first round or to win – and the fact that the market will quieten down considerably during the summer months means that the statistics for Q2 and probably Q3 of this year will not be as high as had been envisaged in Q1.
However, Q1 did see an interesting phenomenon: tenants reading in the general media rather than in the property press, appreciated that the market was no longer falling – particularly in prime West End offices. For the first time in two years, tenants (independently) came to the conclusion that if they did not do a deal on any particular property, there would not be either a better deal available in three months’ time or another property available on better terms. This has resulted in tenants willing to conclude transactions.
Prime rents have stopped falling, but there is not much evidence yet of them actually going up at this stage. Nevertheless, there were Reports published earlier this year that said prime West End rentals would increase by more than 10% during 2010. This sounds significant in the low-inflation economic environment that we have experienced in recent years, but this really only means that prime rents will move from, say, £80 to £90. The level of transactions that this will apply to is going to be relatively small and I am sure that there will be some headline-grabbing transactions that reflect this. This does not, however, mean that the rest of the market will move in this direction – over 60% of the supply is second hand and much of this has problems: shorter leases, personalised fit-outs, over-rented situations, and also much of it has been put on the market by tenants who would love to move but are unwilling to take the pain of subsidising the rent and offering a large rent free period in order to downsize. Much of this space will be removed from the market as Tenant’s business improves and they start re-employing again.
The quite rapid compression in yields for investment property (as well as for owner/occupiers) has slowed. This sector of the market tends to anticipate trends, and this was reflected in the fact that the lowering of yields was signaling the belief that the letting market place would be improving shortly; this having taken place, yields have been readjusted. I think that many investors will see how the letting market proceeds over the next 12 months before jumping on the bandwagon that pushes yields down again.
Trends for rent free period are also an effective indicator of the strength of the market: better space to be let on 10 year leases would have always anticipated not less than 24 months rent free period if let without a break, this is now probably nearer 2 months for every year certain, i.e. c.20 months for that 10 year lease. Competition amongst tenants for better quality space may push this down further.
Tenants who have had their fingers burnt in the past by rent reviews are seeking flexibility at the fifth year. Either a ìcap and collarî at rent review (i.e. a minimum and maximum uplift,) or a break clause at the fifth year on sub 5,000 sq ft transactions can still be considered a normal request by a tenant, but these do come with a cost: usually a reduction in the rent free period as well as a split of the initial rent free period, with some of that being pushed out until after the break. We are starting to notice some more intelligent approaches as well, such as different break and rent review patterns – landlords can achieve a slightly higher rental and an earlier rent commencement, and tenants have that all important flexibility and ability to control their mid-term future.
Landlords are targeting lease events such as tenant’s breaks and lease expiries as the main source of opportunities for tenant churn because, with the exception of mergers, we are seeing very little activity from Companies growing.
The West End offices market has certainly stopped falling and in prime rental situations will see some rental growth, particularly in the last stages of this year. Secondary space, still in great supply, will struggle and continue to distort availability figures. New and newly furbished space will still be in short supply. Tenants are still seeking, and often achieving, more flexibility within their lease terms.