The trouble with a party is that there is always someone who gets overexcited, and takes it too far. So when the West End hit £100 per sq ft at 25 Hanover Square, W1, there was certainly cause for celebration. After all, on the surface, the market looks healthy. Vacancy rates are 5.6% the lowest since 2001 second quarter take-up was a strong 1.4m sq ft, and nine schemes are lined up in the development pipeline to deliver 674,000 sq ft by the end of the year.
But £100 per sq ft lettings are rare. The majority of deals are at a much more mundane £30-50 per sq ft. Yet while most agents seem to be keeping their heads over the hype, saying the peak of the rental market is in sight, the fizz seems to be going to some developers’ heads.
There are signs that prices being paid for land by some developers are getting a little hot.
Those performing ahead of the market all seem to be heavily involved in refurbishments at carefully selected sites, where they can offer space quickly and at rents far below the headlines, says Mark Hickmott, NAI Fuller Peiser’s West End specialist.
“Those coming to fruition in the next one to two years were appraised at lesser rents, and this rental growth is the ‘icing on the cake’ for them,” he says, pointing to the City Corporation’s redevelopment of Alfred Place, WC1, which worked off a rent of a little above £30 per sq ft.
“Where the large rents become an issue is on potential development sites bought off inflated rents, and if the market falls these schemes will not stack up in the immediate term,” says Hickmott.
“There’s a nervousness about interest rates and rising oil costs, and money looks more expensive. If a developer now said it was going to achieve £100 per sq ft and valued a proposal off that, it would be very brave indeed. Most should be looking at around the £50 mark.”
Hammerson’s chief executive, John Richards, warned at the announcement of the company’s half-year results earlier this month that some investors were paying high prices for office development sites in the Square Mile based on over-optimistic rental assumptions.
Increasingly, that is becoming a problem in the West End, too.
With Jones Lang LaSalle predicting the top of this rental cycle in 2010, factoring in rental growth as a given is becoming a dangerous proposal. JLL’s research team says this year will see rental growth peak.
Yet Rob Skioldebrand, JLL’s national director, says some developers have been doing the rounds of agents asking for their best rental growth forecasts, and putting together proposals based on the highest number to justify high bids. “That sounds dangerous,” he says. “Rental forecasts are not designed to be used in that way.”
Speed to market is the key and, explains Skioldebrand, if developers can deliver in the next 24 months, there are still good returns to be made, but he adds: “Thus far, expectations have been met, but I’m not sure it will continue favourably. A lot of developers are bowing out.”
Even using the most bullish forecasts for headline rents, developers need to bear in mind the gap between prime and what is being achieved on a day-by-day basis. Average rents across the board hover around £40 per sq ft a hefty discount from prime (see map, p135). And despite market conditions looking positive, demand for large space is down.
JLL’s figures show 11 requirements in the market for more than 100,000 sq ft. That’s down from a high in 2000 of 27. And occupiers are looking for cheaper space. Those searching in the £70 per sq ft-plus market are down by a half this quarter (see box, p134). Nearly three-quarters of companies are looking for space under £50 per sq ft.
There are few options at this end of the market. According to Cushman & Wakefield, there are seven options for more than 45,000 sq ft, the largest being the 106,000 sq ft Victoria Central, SW1 a distinctly non-core location. The cheapest option is 55,000 sq ft at Broadwick Street, W1, at £40.98 per sq ft albeit for grade B accommodation.
Widening the search to include all quoting rents, there are only 14 options for occupiers requiring more than 45,000 sq ft, and only four schemes in the pipeline at quoting rents of £50 per sq ft.
So, with developers and occupiers seemingly moving in opposite directions, what will happen to the West End market?
Bill Page, head of central London research at JLL, says divisibility will be the key, but he warns: “My concern is that Mayfair and St James’s will become a boutique market for financial services with small floorplates, and that poses a problem with volatility.”
With murmurings that the hedge fund bubble is about to burst, Page’s concerns could become a real problem.
Simon Silver, development director at Derwent Valley, is unconcerned by the talk of doom and gloom. “The market has been strong and there remains a shortage of good product in the West End. Can you think of a single building in London that hasn’t achieved its quoting rent?”
A straw poll of agents suggests not. Yet one suggested a certain amount of manipulation could be behind this. “That’s because developers aren’t quoting rents until the last minute,” he says. “They are putting out rumours and testing the market. It’s indicative of a good market, and it means they will get the quoting rent.”
But Silver could be forgiven his optimism. Most West End players admit Derwent Valley is having a successful year (see p118).
Not only did it secure the largest prelet so far in the West End, with Rio Tinto’s take-up of Telstar House in Paddington, W2, but also lured Burberry out of W1 to put 100,000 sq ft under offer at Horseferry House, SW1, and placed advertising agency Grey in its 50,000 sq ft Hatton Garden scheme, EC1.
“What I am asking is, when is the market going to peak? Will it continue next year?” asks Silver. He believes £100 per sq ft offices have become like a six-star hotel.
“The problems start when people start quoting them in rent reviews,” he says. “Such deals might continue sporadically, but the real market is underneath that, and we are very much middle-tier. We’ve come off low £30s per sq ft to mid £40s per sq ft and, over 18 months, we’ve had a good turnaround.”
Targetfollow, owner of Centre Point, W1, says it, too, has benefited from the Mayfair’s price tag. “There’s a ripple effect of occupiers saying Mayfair is a bit too hot, and are looking further out,” says Ian Fox, a director at Targetfollow Group. “We’ve certainly broken the £40 per sq ft barrier for old speculative space at Centre Point, and we are in talks for £45 per sq ft.”
Will escalating rents and falling supply push occupiers out of their West End homes? Agents say anecdotally that the balance of movers has been into the West End. Figures from Knight Frank seem to back this up. Looking back to 2005, no fewer than six occupiers moved to the West End, primarily from the City.
This year, the trend appears to be reversing, with occupiers exchanging 112,000 sq ft of space in the West End for the City in two deals. With Grey and Burberry the latest examples of corporates shunning a W1 address, has the core reached capacity, and are
the occupiers moving on to the next party?
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The number of occupiers looking for space in the £70 per sq ft-plus section of the West End halved in the past three months. According to Jones Lang LaSalle research, such occupiers dropped from 4% of the market in Q1 to 2% in Q2. Only 10% of these occupiers are prepared to pay more than £60 per sq ft (see chart below). The lion’s share of requirements is in the more mundane £30-50 per sq ft bracket. And it is the lower end of this range that is growing. In Q1, companies seeking space at £30-£39.99 represented just under a quarter of requirements. By the end of Q2, this was up to more than a third. JLL’s report says that when translated into actual floorspace: “£70 per sq ft could be paid on 118,400 sq ft but £30 per sq ft could be achieved on as much as 3.76m sq ft. This is contrary to sentiment in the market, with smaller deals completing at levels over £90 per sq ft, and suggests that cost sensitivity is a dominant driving force for West End occupiers.” Unsurprisingly, it is the financial sector that is prepared to pay high rents, making up nearly half of demand in the £70 per sq ft-plus market. They typically seek between 5,400 sq ft and 10,800 sq ft. Requirements from these occupiers could grow. Experian predicts that the financial and banking sector will increase employment in Westminster by 19% between 2006 and 2010, compared with 6% for total employment. |
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Source: Jones Lang Lasalle |
