The market It is a case of wait and see as developments stall, take-up figures differ and occupiers consider their options. By Nadia Elghamry
Three years ago, Rio Tinto signed a lease for its 100,000 sq ft headquartersin Paddington, W2. Itwas probably one of the last big deals of the boom. The world of commercial property was a cut-throat market for an occupier.Prime rents roseto more than£100 per sq ft and EG reportedrecord take-up in the third quarteras confidence and lettings soared.
“It wasn’t an easy market to play as a tenant. You had to be very quick out of the blocks,” says Rio Tinto’s head of group property, Neil Usher.
The firm’s move to Paddington was prompted by a need to consolidate its offices across Europe. Usher says that when he undertook the search, the market had been rising for well over a decade.”You have to ask if you would do it at all today,” he says.”You only need to look at the lack of activity in London tosee that others are thinking the same, and are sitting and waiting.”
That is at odds with what agents think about the market. Many believe it is time for occupiers to bag a deal – one that will not be around for long, as tightening supply raises the prospect of rental growth.
When the market went into freefall, developers pulled down the shutters very quickly. Now the prospects of finding a property in 2011 are slim. Those looking for a floorplates of more than 7,000 sq ft in the next three years have only four buildings to choose from (see table, p82).
But that cannot detract from the almost 6m sq ft that is available, and the fact that occupiers are hardly tripping over each other to view buildings.
With such a disjoint between the property industry’s hopes and occupiers perceptions, what is the true state of the market?
No occupier is racing to make changes, believes Usher. “I don’t think anyone is expecting rents to jump in the next three to five years,” he says. “There may be a small degree of optimism out there but, even if there is a rise in rents, the level they reach is going to be drastically short of where we were pre-credit crunch.”
He believes that some corporates, particularly those with short lease tails in their existing properties, may start to act counter-cyclically, but he warns thatoccupiers will not necessarily be playing the market.”Many occupiers are not interested in making property decisions right now. At the moment, we are all focused on the core business,” he says.
Usher says:”Recent events have highlighted that you can’t rely on the market to bail you out.”He addsthat, more than ever, this means”you have to be confident about how flexible the space will be for you”.
That confidence is not self-evident. A number of occupiers have yet to settle some significantrequirements, including Capgemini, which is reportedly looking for 40,000-60,000 sq ft, and AstraZeneca, which agents are desperate to see signed. It is in negotiations for 50,000 sq ft at Two Kingdom Street, W2. As one agent says: “If we lost that to the City, it would be pretty damn depressing.”
Time wasting
According to Strutt &Parker, demand is roughly 3.5m sq ft, but it estimates that around only1.25m sq ft of that is active. “There are a lot of tyre kickers out there,” says Simon Knights, the agent’s West End partner.”They’ve heard the market’s crap. There are some coming to us with breaks in two years, and we are practically telling them to go away.”
Struttsresearch shows that, while London occupiers may make a fussin an attempt to get a better deal from their landlords, when push comes to shove, 75% of those with lease breaks opt to stay put. However, when a tenant is faced with a lease end,only one-quarter stay.
That said, Knights believes that incentives will move in by Christmas, and return toa more comfortable 12months rentfree on a 10-year lease, although he admits he bases this forecast on gut instinct from looking at the requirement lists.
Without these, take-up looks set to fester. Depending on which figures you choose to believe, take-up either went up in quarter two this year compared with Q1,or down by 25% – which speaks volumes about the state of the market.
Guy Taylor, partner at Cushman & Wakefield, predicts this year’s total take-up will be below 1982 levels, when just 1m sq ft of space was transacted. “By comparison, in 1991, it was nearly 2m sq ft. Rents are half what they were at the peak, and take-up is down 70%. Occupiers are regearing leases, and most are staying put because it is cost neutral.We are truly at the bottom and rents might tweak down.”
That is echoed by Neil Gorman of C&W’s client solutions team.”Occupiers are craving certainty, and fixing or removing dilapidations – anything that gives the finance director a safety valve,” he says. “It’s brought the real estate directors to the fore. Property has gone from being a secondary cost to being highprofile.”
Some buildings appear to be defying gravity, such as 23 Savile Row, W1, where the sixth floor is occupied by investment manager Altima Partners at £93 per sq ft. A further two floors are under offer at more than £90 per sq ft to investment firm Resolution and private equity company General Atlantic Partners. But generally, across the West End, rents are continuing to slip, and incentives are peaking at more than20 months rentfree.
Add in that four of the top-10deals in the West End to date this year are for less than20,000 sq ft, and 70% of all leases signed in Q2 are for less than 10,000 sq ft, and it is easy to see why there is a sense of horror among already careworn West End agents.
Sense of caution
Even those reporting rising take-up are circumspect. CB Richard Ellis’s estimates that take-up went up in the West End for the first time since Q2 last year. But Simon Tann, senior director in its West End agency, urges caution.”You’ve got to be careful because there are so few deals out there at the moment, and it only takes one to make things look better. It’s significant, and confidence has changed, but I’ll be happier when we can look at the annual trendsas I think the statistics will get worse for a little bit.”
Faced with that prospect, it is hardly surprising that the development pipeline has been turned off. According to CBRE, 2.2msq ft is due to be delivered in the short term, while work has stopped on 700,000sq ft. “It’s got to a point that, unless we see a digger turn up on site, we don’t believe it is going ahead,” says Tann. “You might have planning consent, but it is all about raising the financing.”
Several high-profile projects have been put on the back burner, including those by some big developers. Land Securities announced over the summer that it was halting work on its Park Street development, W1. For now, the prime piece of real estate on the Oxford Street site will become, among other things, a five-a-side football pitch. The developer is hoping to digagain in 2010 for delivery in 2013. Other developers in W1, such as Great Portland Estates at Wigmore Street, McAleer & Rushe Group at Baker Street and Henderson at French Railways House on Piccadilly, are believed to be taking short-term lets.
But what about developers with schemes that are well advanced? One of the few taking their chances is Heron International, which is building the 78,000 sq ft The Peak next to Victoria Station, SW1, in a joint venture with AXA and CIS. Peter Ferrari, joint managing director of Heron, points to the positives, which includea vacancy rate of 5.5%, which is down month on month, and the “very tight supply situation”.
Is he worried at all about letting the building? “I’m very confident. There is demand for new space in London. We are not talking about some backwater here,” he says.
That said, he admits that take-up is substantially down, and many occupiers are choosing to renegotiate with their landlords. However, he adds: “At a time of subdued demand, it all migrates to grade A stock. If you look at Savills’recent occupier survey, it says costs have moved to the top of occupiers’ lists, so Victoria is probably looking more attractive to typical West End occupiers looking for cost-effective locations.”
Ferarri will not discuss how cost-effective The Peak will be, stating that no marketing has been done on the building, which will be finished late autumn. But, according to Strutt &Parker, rents in Victoria have reached £52.50 per sq ft on grade A space on a lease of more than five years, and Jones Lang LaSalle says that declines in annualised returns in the area are approaching 9% (see p86).
However, Ferarri is bullish, stating: “I don’t want to talk about headline rents as we are putting a great product into the market. We are the only building in Victoria, and I won’t be giving it away.”
