London office landlords are scaling back rent-free incentives as demand for grade-A space strengthens.
Rents across the central London office market were relatively static over the 12 months to the end of June, according to analysis from Carter Jonas – rising by just 0.2%, driven by the Mayfair and St James’s submarket.
The firm’s latest Central London Net Effective Rents Monitor tracked headline rents and the length of rent-free periods across 22 submarkets of the capital. Despite largely flat prime headline rents, the declining value of incentives has led to an increase in net effective rents for prime grade-A space. On average, net effective rents have increased by 5.5% over the past year assuming a five-year lease, and by 3% assuming a 10-year lease.
The driving force “has been the structural shift away from low-quality space with poor environmental credentials and the constrained supply of high-quality, energy-efficient accommodation”, the report said.
It added: “Prime net effective rental levels will therefore be most resilient in the West End and Midtown, where quality space is in the shortest supply and will not be replenished rapidly due to low levels of development.
“In the City, downward pressure on incentives over the past year has been largely limited to the upper floors of tower buildings. However, this submarket could increasingly benefit from a migration of occupiers unable to find suitable quality accommodation in the West End, further encouraged by the opening of the Elizabeth Line.”
Net effective rents in central London are edging towards pre-pandemic levels. Prime headline rents fell by only 1% from peak to trough and are currently 0.8% below their pre-pandemic low. In contrast, net effective rents fell sharply – by 8% on a five-year lease and 6% on a 10-year lease – and now stand at 2.9% and 3.1% respectively below their previous peak.
Not all submarkets fared the same. The greatest gains were seen in the West End, where low levels of grade-A vacancy have upped competition between tenants and seen increases in advertised rents for best-in-class space.
The past year has seen prime West End headline rents rise by a modest 0.9%, but net effective rents have increased by 8.6% for a five-year lease and by 5.3% for a 10-year lease. This means both headline rents and net effective rents for a five-year lease in the area are now back to their previous pre-pandemic peak.
Falling rent-free incentives have resulted in an increase in the prime net effective rent for all central London of 0.8% during the second quarter, assuming a five-year lease. Meanwhile, 10-year leases have seen stable rent-free periods over the past quarter.
However, Carter Jonas now expects to see landlords lose some of their edge when it comes to negotiations.
“Occupier demand faces the combined headwinds of economic uncertainty, rising inflation, and an ever-sharper focus on costs, as well as the ongoing working from home revolution,” the team said.
“It is therefore likely that occupational demand for office space across central London will weaken during the remainder of 2022, reducing the bargaining power of landlords.”
The agency added: “It is important to note that these trends apply to grade-A stock and are not representative of the wider market for secondary space, where there remains ample supply.
“Given the increasing focus of occupiers toward high-quality green space, there is unlikely to be any significant upward rental pressure in this market segment over the next year, with the possible exception of better-quality secondary stock in those submarkets where the supply of quality space is most constrained – notably prime locations in the West End.”
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