LONDON OFFICE MARKET

London Office Market - Rent Reviews... Remember Those?

All markets are cyclical.  What goes up, must come down and all commercial markets, including the London West End office rental market, enjoy periods of growth, followed by periods of recession and decline.  And then the cycle starts all over again.

Usually these market fluctuations are fairly gradual.  Tenant confidence ebbs and flows in line with economic indicators as does landlords’ and developers’ appetite to build and provide new supply to the equation.  However, in 2008, micro-economic factors largely went out of the window as the global recession set in.  In reality this too was a gradual process: alarm bells rang as early as 2005/2006 with the bursting of the US housing crisis and the knock-on effect felt by those lenders who had invested heavily in America’s sub-prime residential sector.  The run on Northern Rock in late 2007 was the first time such scenes had been seen on the UK’s high streets for 150 years.  At this point, it was evident that the sub-prime crisis on the other side of the Pond could have global effects.  However, it was not until late 2008 that the real extent of the recession was truly felt.  Desperate, last minute pleas to private and state benefactors fell on deaf ears and Lehman Brothers filed for bankruptcy, turning their lights off on the morning of 15 September 2008.

The demise of Lehman Brothers sent shockwaves over the global economic landscape and has had a pronounced effect on commercial real estate – particularly in prime, established markets such as London’s West End.  All markets have suffered but emerging markets are able to recover relatively quickly due to smaller stock, cheaper commitments and more volatile, reactive landlords.  Developed markets, such as London, New York and Tokyo, have seen a slower recovery.

Prime rents in London dropped 30% in the immediate aftermath of the demise of Lehman Brothers and, for a while, the upwards only rent review provisions in leases became largely irrelevant.  Tenants became used to the fact that they were ‘over-rented’ and landlords have struggled to realise any rental growth from their investments.

Five years have elapsed since the collapse of Lehman Brothers and the bottom of the most recent market cycle.  For the first time since 2008, rent review surveyors are not comparing today’s market rents with those settled at the peak of the market in 2006 and 2007.  Those tenants that took advantage of the market downturn discussed above, will have rent reviews in late 2013 and 2014 and, as such, could face significant rental uplifts going forward.  Prime rents have bounced back and there is little sign of these increasing market rents abating.  Where landlord agents, in 2012, just about managed to breach the psychologically important £100 per sq ft ceiling, a number of deals have been agreed north of this rate: Temasek, the Singaporean sovereign wealth fund, has recently agreed a new lease in St James’ at £130 per sq ft and Noble Energy has leased Devonshire House in nearby Mayfair at a headline rent of £120 per sq ft.

To make matters worse, developers have been tentative when it comes to the new supply of prime Grade A offices.  This has led to competition and artificially inflated rents for the in-demand, quality office space.

However, rents in the West End will not automatically increase on review – while there is competition for the Grade A space, this is not reflected across the whole office landscape.  Higher vacancy rates means more choice and greater negotiation leverage for tenants.

There will likely be a number of major battles between landlords and tenants over the next 12-18 months.  Landlords will be relying on prime evidence in their opening rent review offers and will be keen to increase rents across the board following five years of stagnation.  Tenants, if they are correctly advised, will table more relevant transactional evidence in an attempt to drive down the landlord’s position.  At ask-re we relish the opportunity to get stuck in to landlords in these challenging negotiations and regularly beat the market and our clients’ expectations.  We only ever act for tenants, never landlords, and are thus never hampered by conflicted interests in our negotiation strategies.  Timing is key, both for the formulation of the right strategy and for realistic property cost budgeting.  The ‘over-rented’ days appear to be behind us, but there is still value in your lease and ask-re is the right partner to help you unlock this value.