Gloomy picture: Market figures for the fourth quarter of 2007 do not make for happy reading. Nadia Elghamry reports
Those of a nervous disposition may want to turn away now. According to provisional figures from Jones Lang LaSalle, City investment notched up its slowest quarter for more than eight years at the end of 2007.
For those hoping for a soft landing, the figures turn nebulous worries into stark reality.
Despite morale-boosting deals involving significant amounts of debt at Condor House, 16 Old Bailey, and 100 Ludgate Hill – all in EC4 – totalling more than £200m, just £677m was traded in Q4. This was the slowest quarter since September 1999 as the paralysis which has hit investors fed through to market figures.
Even taking into account the bull run at the start of 2007, annual figures were 6% short of 2006’s record, at £9.4bn.
The West End’s investment market fared slightly better, trading £805m in the quietest quarter since Q1 2005. Even with cash-rich Middle Eastern buyers and others largely unaffected by wobbles in the funding market eyeing the market, an annual total of £6bn was 2% behind that invested in 2006.
Some think a marked correction is on the way, with occupiers subletting space and undercutting landlords on rent (see below). Others are calling it “constipation” in the market, with a short sharp shock in the investment market working its way through Q1 of this year, while lettings remain on track and largely unscathed.
“Given the instability in the financial sector, 2007 did not finish as badly as we might have feared in September,” says William Beardmore-Gray, head of City offices at Knight Frank. “Q4 was predictably slow. However, 2007 overall saw similar levels of take-up to 2006, if not slightly better.”
Figures from Merrill Lynch seem to back the latter up. As 2007 ended, corporate profitability remained the the strongest on record since 1965, notching up an impressive net rate of return of 16% by the autumn.
That seemed to filter through into the chronically undersupplied West End, which remained strong in Q4. Take-up of 80,500 sq ft was in line with the long-term average as occupiers continued to fight for space and push up rents.
Prime rents reached £115 per sq ft – up a massive 21% on 2006. Over the year, demand increased by 9%, says Bill Page, head of offices research at JLL, with new requirements for 4.5m sq ft – and more than 1m sq ft of that in the last quarter – indicating further expansion in the market.
Yet even here, completions drove supply up 18% – the first increase since the end of 2004.
There was no such cheer for the City market. Expansion in the financial sector took a hit as lettings dropped 40% on the 10-year quarterly average, ending Q4 at 960,000 sq ft. More worringly, the proportion let to the banking and finance sector dropped to 19%, compared with the long-term average of almost a third.
However, large requirements increased in dominance, with 60% of all demand for units in excess of 100,000 sq ft. Prime rents of £66 per sq ft in the City stagnated in Q4, and Page says little movement is expected this year.
What does 2008 hold for London’s commercial property industry?
With the phrase “credit crunch” quickly entering the corporate lexicon of blame in much the same way as the dot.com boom and bust and 9/11, many are looking to 2008 for sources of optimism.
But the first weeks of January have brought few. As the new year got under way, a string of retailers issued profit warnings.
The CBI downgraded its forecast for the UK economy for the third quarter running and, closer to home, NB Real Estate delayed paying its staff bonuses as a “cautionary measure”.
In London, the GLA is predicting that growth in gross value added will drop from 3.3% in 2007 to 2% in 2008. Employment growth, which had already nearly halved in 2007 to 1.2%, is predicted to slow further over the next two years. Will this mean a bumpy ride for the property market?
Richard Lambert, director general, CBI: “This will be a difficult year for British business. The economy has started a cyclical slowdown of uncertain depth and duration. The Bank of England had raised rates five times in 13 months. By the late autumn, output growth and consumer spending were both coming off the boil. But two big shocks have hit the system in the past few months, and made the outlook much more uncertain. But it is important not to exaggerate the risks. The most likely outcome is that the coming 12 months will be a soft – as opposed to a hard – landing, after two years of above-average growth.”
Clive Bull, head of central London investment, Cushman & Wakefield: “A rapid price correction is taking place, and many institutional buyers will be sitting out the London market. In the West End market in particular, however, cash-rich private investors and overseas buyers will be taking advantage of what they see as the world’s most prestigious office and retail market. On Oxford Street, prime yields of around 4% have now moved out to around 4.5%-plus. The biggest change has been prime offices. Mayfair, for example, was sub-4%, and is now around 5%. These yield changes are partly a proper correction, as prices have been driven too high, as opposed to just a fall in the market. Also, as West End office rents have moved up so much, it is logical that yields should soften as there is less growth to come.”
Charles Killen, joint senior partner, EA Shaw: “Space available in Midtown is primarily landlord space, but through 2008 we expect more direct marketing from tenants, possibly providing better deals and lower rents. Although demand may fall slightly, it will still be at a healthy level. However, deals could be prolonged as Midtown loses a few occupiers to the City, with tenants considering better financial options. The true market will not become clear until March, when the financial markets have settled. Rents will remain level, with the possible exception of trophy buildings, and new leases could see rent-free periods start to increase.”
Stephen Bennett, investment director, GVA Grimley: “While 2008 is likely to be sluggish, I suspect future historians will note it as the year which marked a return to the importance of long-term fundamentals and for re-establishing an appropriate yield differential between prime and non-prime property. Assuming tenant demand remains fairly robust, secondary property will generally be bought by UK property companies and private investors, looking for arbitrage. Assuming that borrowing rates continue to improve through 2008 as base rates fall and the credit crunch eases, this would imply secondary yields between 6.5% and 7%, with prime yields eventually settling between 5.25-5.5%.”
Andy Heath, West End business team, Strutt & Parker: “We see opportunities for the West End office market arising from the amount of demand from the Brazilian, Russian, Indian and Chinese economies. Companies such as Gazprom require grade A accommodation in prime locations. Threats to the West End office market are those companies facing lease expiries or rent reviews. With potential large rental rises, tenants which are footloose could end up locating to the City, Hammersmith, W6 or out of town.”
Economic indicators at a glance
Corporate profitability remained strong in 2007 Q3, according to Merrill Lynch, with a net rate of return rising to 16% – the strongest on record since 1965
House prices rose 0.6% in November, according to the Land Registry, increasing from 0.1% in October. On a three-month basis, house price inflation fell from 1.4% to 1.3%, continuing to slow from a peak close to 3% in the spring
Inflation is expected to rise, according to Merrill Lynch, which forecasts that a 15% rise in energy prices could add 0.6% to inflation
GDP growth slowed notably from 0.7% in Q3 to 0.4% in Q4. After downgrading its forecast for the UK economy for the third quarter running, the CBI predicts this year’s annual rate of GDP growth will be 2%
