Squaring up Nomura’s move at Watermark Place sparked a waterfall of City deals. Who will be left high and dry? Nadia Elghamry reports
The London marathon has turned into a sprint to the finish. The prize is a home in the best space in the City.
For occupiers,the change of pace has all come as a bit of a shock. Those eyeing the Square Mile had become confident they could bag a bargain and, having launched grand requirements, waited to see which developer would bite. But last month,Nomura broke ranks.
The Japanese bank signed for the entire 520,000 sq ft Watermark Place, EC4, in a deal that made the industry gasp at its generosity. Owners UBS and Oxford Properties agreed four years rent free with the equivalent of nearly another two years in fitting-out costs, in exchange for a hefty 20-year commitment from Nomura.
In its wake, the deal left around 1m sq ft of major requirements looking wrong-footed. Bloomberg was expected to choose between Watermark Place and Minerva’s The Walbrook, EC4, for its 400,000 sq ft requirement. Both MF Global and Catlin had also shortlisted Watermark Place in their searches for 100,000 sq ft HQs.
In the weeks that followed, City agents clammed up. Many were huddled in client meetings, as property directors with flushed faces made furtive phone calls to their boards. The secondary market was still a mess (see below) but, after months of assurances that the deals were out there for those who blinked last, they now had to admit that, for the best space, the pickings were very slim indeed.
Lawyer Pinsent Masons’deal at 30 Crown Place, EC2, quickly followed, If Canary Wharf Group and Exemplar sign either investment manager Blackrock or financial services company Macquarie at their Drapers Garden scheme, EC2,only one building -The Walbrook, with 440,000sq ft of space – is not already signed for or shortlisted. After that, occupiers will need to wait for Heron Tower and the Pinnacle in 2011.
Those looking for space are now playing a nasty game of musical chairs. US law firm Stephenson Harwood is believed to have agreed terms for 110,000 sq ft at St Martins’ 150 Cheapside, EC2. The letting means Majedie Investments and TLT Solicitors, which were under offer for 12,000 sq ftand 22,000 sq ft in the building respectively, have been forced to look elsewhere.
UK insurer Allianz is also having to rethink its options after being displaced at 20 Gracechurch Street, EC3, following underwriter Catlin’s take-up of 115,000 sq ft in the building.
“We were all waiting for that one big deal to happen,” says Neil Prime, head of markets group at Jones Lang LaSalle.”We knew it had to. Quite a few parties were looking at Watermark Place, and they’ve got dislodged from their preferred location. Suddenly, they have realised that, out of three buildings, they are down to two.” But he cautions:”Before we get carried away, we need to remember I’m talking about the top 15% of the market.”
The shift in the market has also left agents scrabbling for their calculators as forecasts on future rents are re-evaluated. King Sturge predicts that incentives will peak this year at 36 months, and net effective rent could be up to just under £32.50 per sq ft by next year (see graphs). Forecasts are under reviewbut, on the “very top thin veneer”, the best space could be £44 per sq ftby the year’s end, says Mark Bourne, head of KS’s City office.
He adds: “The tide is turning, and we are about to reach the bottom for the best stock.”Landlords now seem to be holding out for more, he says.
The asking rents for Drapers Garden are believed to be in the mid-£40s per sq ft and, at the Walbrook, EC4, Minerva is thought to be holding out for a rent with a “5” in front. This is bullish indeed for a company that, just a few weeks ago, had to fight to extend deadlines on £700m of loans, and was given a £300m lifeline.
Pragmatic view
For landlords, it has been a painful trip to this point. As anexample, Ben du Boulay, head of central London offices at Invista Real Estate Investment Management, points to its Exchequer Court, EC3, also the home of its City HQ. “We did a deal in this building that is now looking soft,” he says.But he adds: “We took a pragmatic view to get it let. There’s been a change over the past two or three weeks, and now the market might think we have a half-decent chance to better it. But you’ve got to weigh the deal up against vacant building costs.”
Take-up in the third quarter also increased – for the first time in a year. Steve Johns, City partner at Cushman &Wakefield, says it was more than 1.4msq ft. “That’s more than triple Q1 and around the 10-year average, although that has been swayed by the large deal at Watermark Place,” he says.
Again, the best prime space is driving the market. Of the 13.4m sq ft of available space in the City, 6.7% is grade A. But, of a total City take-up of 2.6m sq ft, 90% was grade A.
The flood of grey space many feared has failed to appear. As a result, Johns says that he can see developers taking schemes out of the deep freeze next year. “Yes,” he says, “people who can regear leases are doing so, but there are only so many times you can do that before it is entirely obsolete, so we’ll soon see some buildings getting refurbished too.”
Investors return
Cash investors are definitely back in the City – but can they find anything to buy? According to Jones Lang LaSalle, £1.7bn was spent in the Square Mile in the third quarter – the most since the summer of 2007. Overseas institutions provided a massive 82% of that cash, nearly two and a half times the amount in both of the previous quarters this year added together, and all but squeezing out UK investors.
Ben du Boulay, director of London offices at Invista, knows the situation all too well. He says: “This is the tightest I’ve ever known it. We’re having to contend with foreign private companies, and we can’t compete.”
Since 2004, Invista has sold £3bn of property in 68 buildings. “We’ve been buying and selling a hell of a lot and, like everyone else, we’ve been hammered on our capital values,” admits du Boulay. “Rents have fallen, yields have moved out, so the City is incredibly interesting at the moment, but we won’t be spending every last penny there.”
Through its Opportunity Fund, the company has £100m to invest and a further £200m in additional funds. Invista has never been interested in the “really frothy rents”, and is looking for “buildings where there is some bounce in the rents, which we try to coincide with leasing events”, du Boulay says.
Henderson is also keen to get going in the City. Mike Sales, fund director of Henderson’s Central London Office Fund, and the company’s head of property in the UK, says that its existing fund has focused on the West End and Midtown. Through its new Central London fund, which closes next month, Sales hopes to raise £150m-£200m.
“City investment is very exciting,” he says. “There’s a major repricing going on, sentiment in the occupational market is much more positive and there’s been a surge of activity from the tenants at the prime end.”
Sales says prices are increasing. “That will cause more stock to come onto the market,” he says. “Not much has been released by the banks, and quite a lot is coming up for refinancing in the next two to three years.”
Vacant space rises in secondary market
While the prime market shoots upward, market forces are dragging the secondary market in an entirely different direction.
Neil Prime, head of markets group at Jones Lang LaSalle, points to what he calls “a huge underbelly of secondhand space”. Rents are under pressure and lease flexibility is now “continuous and consistent”, he adds.
By the end of Q3, King Sturge says, more than 2m sq ft of secondhand space was empty, a figure that, while significantly less than the peak in 2004, has been steadily rising since the beginning of last year.
This is the main reason why City vacancy rates stand at 12.3%, says Deborah Hayward at KS’s City research department. She believes that, as a result, secondary space will dominate the market in 2011 and 2012.
KS is predicting that rents on secondary space will continue to slip. By the end of next year, they could have fallen from £37.50 today to around £32.50 per sq ft.
