Dare to think the unthinkable: an undersupply in the City of London

By Deirdre Hipwell

Leasing agents in the City of London are almost genetically programmed to see the upside in any market situation.

Even after the worst first-quarter performance in 20 years this year, when less than 300,000 sq ft of office space was taken up, there remained a determined, sometimes desperate, confidence that the Square Mile faced more of a risk of undersupply of the best office space than oversupply.

The events of recent weeks may yet prove them right.

In the eight weeks since Nomura agreed to occupy the whole of UBS and Oxford Properties’ 541,000 sq ft Watermark Place, a further 470,000 sq ft is close to or has already been placed under offer at 30 Crown Place and Drapers Gardens.

This is in addition to Bank of China agreeing to occupy — with an option to buy — Goodbody’s 117,500 sq ft One Lothbury scheme. Hammerson has achieved a healthy maximum rent of £47.50/sq ft and nearly let the whole of 60 Threadneedle, winner of City development of the year at last week’s Offices O9 conference, while Aviva Investors and Atlas Capital Group has almost fully let 20 Gracechurch Street.

And even though strong-covenant tenants AllianceBernstein and AstraZeneca may have turned their noses up at City schemes, there is still a range of big-name occupiers trawling around for space, such as Blackrock, Clyde & Co, Bloomberg, and Royal Bank of Canada.

But for tenants looking now for more than 200,000 sq ft in the City, the choices have suddenly shrunk to British Land’s Ropemaker scheme or Minerva’s Walbrook.

And those that have to move because of an upcoming lease expiry may find landlords are gaining the upper hand as rents and terms will start to harden.

Digby Flower, executive director at CB Richard Ellis, says effective rents on the best space in the City will now start to improve more quickly than “headline” rents, as the rent-free periods landlords are prepared to grant reduce. He says rent-free periods are likely to fall by as much as 12 months quite quickly as landlords seek to “get to the cashflow sooner”.

But the agents may not want to pack away their cheerful optimism until the next downturn just yet, as it is still far from plain sailing in the volatile City market.

Gerald Ronson, chief executive of Heron International, speaking at Property Week and CoreNet Global UK’s Offices 09 conference last week, warned that, although London’s rental growth prospects look keener, “we are only two years into this nightmare”.

Nomura watershed

There is also still heated debate over whether landlords are giving away too much in their haste to secure occupiers.

Nomura’s 48-month rent-free period, which with other base build contributions equated to a rent-free period of six years, generated a mixed reaction and headlines as far afield as Singapore. However, Nomura was a watershed deal of more than half a million sq ft of speculatively developed space let to a good-covenant tenant on a 20-year lease following the world’s worst financial crisis.

UBS would have been mad not to do the deal and, although those terms may not be replicated, they are not to be sneered at.

Nomura’s was the first of a clutch of deals that have entirely shifted the City market — at least for grade A space. There are still fairly high levels of supply of secondary space, of which tenants looking for less than 50,000 sq ft may have their pick.

We are not there yet but talk of recommencing development in the City may start again. The prelet market is still too expensive for tenants, because no developer will undertake a scheme unless it can secure a rent of at least of £50/sq ft and a guaranteed profit.

In addition, construction costs are still high and, although predicted to fall a further 3% in the last quarter, they are nowhere near as low as they were at the start of the last development cycle. Nor is there that much evidence of any significant return by the banks to the development finance market, so developers may have to look to other sources for forward funding. But the shift between supply and demand is moving in the right direction.

“In London, unlike the last recession there has not been overbuilding. We will see a change in the pattern of falling rents as there is not a lot of property available,” continues Ronson.

“If you look ahead into next year, when these buildings are gone, when developers are not building, and banks are not lending, there will be demand. Rents will go up.”

Nicely in time for the completion of Heron Tower in 2011. (Deirdre Hipwell, Property Week). http://www.propertyweek.com/story.asp?sectioncode=38&storycode=3152149

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