Long road back Glum, grim, shock, decline, downside – the vocabulary used to describe the West End’s prospects is almost unrelentingly depressing. And, as Nadia Elghamry reports, there are few slivers of sunlight on the horizon
Psychiatrist Elisabeth Kubler-Ross would have one phrase for it: “stage three”. The famous Swiss proponent of the Five Stages of Grief would probably place West End agents at the bargaining stage.
Having been through denial and maybe anger, they have only depression and finally acceptance left.
For those all-important corporates – the ones that eat into take-up figures – there is little good news on the horizon. Indeed, there could be much worse to come. House prices are still falling, inflation is rising and sterling is feather light.
So, as the third quarter gives way to the fourth, how much worse can it get – and when will it all end?
Casting an eye around the West End agency market, there are more glum faces than in the front row of a Smiths’ concert.
“It’s hard to be positive,” says Kelvin Davidson, property economist with Capital Economics. “Until recently, there was a widely held view that the occupier market would be OK and that yields would readjust overnight. But house prices are still falling, and the numbers are pretty grim.”
Davidson says that, despite his firm being one of the most bearish analysts around, it has been surprised at the pace at which things have slipped. He says: “We are looking at a scenario of next year being a recession, and it all looks bad. There is now evidence that people are losing their jobs.”
The firm predicts that financial and business service sector output will plummet, dragging down with it employment, household spending and average earnings (see table). It believes that GDP will grow by a fraction more than 1.5% this year and will expand by only 0.5% in 2009.
“Profound and long lasting” were chancellor Alistair Darling’s thoughts on the downturn this month, and that is a conclusion that many economists seem to agree with.
Davidson believes that the correction will be slow. “We’ve pencilled in some modest recovery for 2010,” he says, “but, if I had to give a risk to those numbers, it is on the downside.”
Prospects for the West End are “pretty grim”, he adds, with falling service-sector employment leading to poor rental growth.
Capital Economics research indicates that West End office rental values will fall by 25% by 2010. The biggest annual fall will come next year, when a 15% drop is anticipated.
“We’ve already seen the West End and City fall based on the IPD numbers,” Davidson says, “and it is going to get much worse in our view, especially in the West End.”
He says the traditional view that West End rents will remain strong because the area’s supply is constrained is flawed. “The fact that rents have already fallen undermines that argument,” he says. “Looking at the supply figures on the development pipelines, they are not trivial.”
In a softening labour market, that creates a problem. Over the summer, the Chartered Institute for Purchasing & Supply said that its index of the service sector, a barometer for performance, shrank for the third month running. The service sector accounts forthree-quarters of the economy and 40% of West End take-up.
Further bad news came in August when KPMG and the Chartered Institute of Personnel & Development issued a report stating that just 29% of employers planned to hire staff in Q2.
The British Chamber of Commerce now warns that recession is looming, and predicts that UK unemployment will rise by between 250,000 and 300,000 in the next 18-24 months.
Pile on the demise of Lehman Brothers and Merrill Lynch, and it all looks pretty miserable.
As more people enter the jobs market, average earnings growth will slow. This, coupled with high inflation, will drag consumer spending, and the economy, even further downhill.
And this is starting to wash up on landlords’ balance sheets.
A nationwide survey carried out in Q2 by the CBI and GVA Grimley found that fewer firms were expanding their property holdings. At the beginning of April, 15% of occupiers polled had increased their space compared with 22% in the six months preceding.
More worryingly, almost three-quarters expected to reduce their space in the coming six months. Among those retaining space, 22% said that they had restructured a lease to lower their occupancy costs, and 19% said that they had obtained a reduced rent.
According to Jones Lang LaSalle, figures show that the proportion of space let to the banking and finance sector in the West End – the sort of lettings which drive headline rents – has halved this year to 16%, compared with a 10-year average of 28%.
Watertight leases have so far protected landlords but, as companies struggle, they will cut costs. This could lead to some short, sharp shocks for the market, says Tony Parrack, partner at Edward Charles.
“Historically, if a tenant is paying £70 per sq ft and you tell them it is worth £90 per sq ft, they immediately say, ‘I’ll sublet it at £75 per sq ft’ – and bang! It’s gone down in one big fall.”
Some have drawn comfort from the idea that the falling value of sterling might help boost exports – it slipped to its weakest level in 12 years on 29 August. Yet David Stubbs, senior economist at the RICS, warns about reading too much into this.
“These things work with a time lag,” he says, “and it is one of the reasons we’ve seen the US picking up. What people forget is that the US dollar has been in decline since 2001.
“I don’t think we will see net trade into the UK affect the economy. People say you need a year for exports to reprice.”
Stubbs believes that we are halfway through the correction but still in the eye of what he calls the perfect storm of the credit crunch, with consumers buffeted by the gales of fuel and food price inflation.
The consequence for property, says Stubbs, is that while capital values have already dropped away, “the next leg down is tenant demand slackening off, and that feeds back into lower capital values because buildings are valued off rents too”.
He adds: “Unemployment is rising in big steps. We’ve had a very pessimistic view from Bank of England governor Mervyn King about the economy, and that will certainly feed through to offices.”
But there are some weak glimmers of hope. Matt Probert, assistant director in Ernst & Young’s real estate division, believes that inflation will fall over the next few months as easing political tensions allow oil prices to relax further.
One flashpoint will be pay rises. Probert says: “This could push on inflation. We are hearing rumblings from the union people that they are pushing for 5%, 6% or even 7%. Employers prefer to pay around 2-3%.”
The tightening credit line is only now beginning to feed through to the wider economy. That, says Probert, will begin to feed through to the West End occupational market, as advertising agencies rein in advertising spend.
“We haven’t seen the worst yet,” he believes. He points to banks which have been slipping a few billion “here and there” onto balance sheets. “We’ll see more write-downs, and that will affect investment in property in the West End,” he says.
He concludes: “The institutions are sitting on their hands, and the only people who will make money are the opportunity and sovereign wealth funds. They are the only ones who can play a little higher up, and they are happy to take the long-term view.”
