Real Estate Research
Central London Offices: Stick or twist?
2013 was another bumper year for the central London office market. Capital continued to flood into the West End and the City, driving down yields and the pick-up in economic sentiment fed through into improved demand, lifting rental values.
2013 was another bumper year for the central London office market. Capital continued to flood into the West End and the City, driving down yields and the pick-up in economic sentiment fed through into improved demand, lifting rental values.But have we had too much of a good thing? Yields in core markets are back to their peak levels, whilst prime rents are approaching previous highs. And with central London notoriously the most cyclical UK property market, is now the time for investors to start taking their chips off the table?
How far into the rental cycle are we?
One of the first questions to try to answer is how far has the rental recovery got to run? Prime rental values in core St James and Mayfair are almost back to peak levels, whilst in some markets such as Soho new rental peaks have been achieved.
Although some markets, particularly in the core, are starting to look a bit ‘frothy’ it is important to remember that by and large these are exceptional deals in a rarefied part of the market. Yes some occupiers in Mayfair and St James have recently taken space at £110 per sq ft, but the average rental level in the IPD West End sample is £40 per sq ft, whilst in the City it is still £34 per sq ft.
Indeed if we look at ‘average’ IPD rental values in real terms, then we see that the recovery is at a far more embryonic stage (see figure 1). In real terms, West End rental values have only grown by 7% since the bottom of the market in March 2010 and remain 23% below their previous peak. In the City, we have barely seen a recovery in real rental values at all, with average rents still 25% below their 2007 peak. This would suggest that if the supply/demand characteristics are favourable, then we should be set for a sustained period of rental growth.
Encouragingly there is also significant capacity for income growth, particularly in West End portfolios. The chart below shows the reversionary potential of all the IPD PAS (Portfolio Analysis Service) segments. As the chart indicates, the level of income currently received by investors in the West End and City office markets is currently some way below the open market rental value. This suggests that there is significant reversionary potential for existing investors at future lease events.
The views and opinions contained herein are those of Patrick Bone, Head of UK Property Research,and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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