September 2015
For professional investors and advisers only. This document is not suitable for retail clients.
Schroder Real Estate
When will Central London
office rents peak?
Central London offices have recently been the star performer of the UK commercial
real estate market. Total returns on City and West End offices averaged 14.2%
per annum and 16.1% per annum respectively over the five years to June 2015
(source: MSCI), well above the all property average of 10.1% per annum.
Mark Callender,
Head of Real
Estate Research
While part of this outperformance was due to a relatively favourable fall in yields, this re-rating
was supported by a big upswing in rents, reflecting both strong employment growth and low
levels of new office building. Average grade office rents in the City and Mayfair have risen by
50–60% from their trough in early 2010 (source: Co-Star /PPR) and certain areas such as
Shoreditch and the South Bank have seen even faster growth, as they have graduated from
fringe locations into integral parts of the Central London market. Given that property yields
appear unlikely to fall much further, assuming that interest rates start rising in 2016, the key
question now for investors is when will Central London office rents peak?
Chart 1: Central London Office Rents
Average rent, £ per sq ft
75
65
55
45
35
25
Jeremy Marsh,
Real Estate
Research Analyst
15
2000
2001
2002
Soho
2003
2004
2005
Paddington
2006
City
2007
2008
2009
Southbank
2010
2011
2012
Shoreditch
2013
2014 2015
Q2
Mayfair
Source: Co-Star / PPR, August 2015.
That Central London office rents are now above their previous peak may leave some
investors feeling queasy, but the 2008 peak is an arbitrary level rather than an important
milestone (see Chart 1). Looking forward, what really matters are the future demand and
supply forces shaping the occupier market. On the demand side, Oxford Economics
forecasts that office employment1 in Central and Inner London will increase by 12%, or
200,000 people, between 2014 and 2019 (see Chart 2). Encouragingly, this expansion
should be based on a range of diverse sectors, as London continues to develop as an
international hub for IT, media and professional services (e.g. accountancy, architecture, law
and scientific research). By contrast, employment in financial services is likely to be flat and
cuts in government spending mean that jobs in public administration are expected to decline.
Office employment is defined as administrative services, financial services, IT and communication, professional services
(e.g. accountancy, architecture, law, management consultancy, scientific research ), public administration and real estate.
1
Schroder Real Estate When will Central London office rents peak?
2
Inevitably, there are risks around these employment forecasts. Recent volatility in equity and
commodity markets reflects worries that the slowdown in China could be much sharper than
previously anticipated. Likewise, there are concerns that the IT sector could falter, although it
seems unlikely that it will suffer a trauma like 2000–2002, when the industry was dominated
by start-up companies with lots of promise, but no revenues.
Chart 2: Central London Office Employment
Employment, million
2.25
2.00
1.75
1.50
1.25
1.00
0.75
0.50
0.25
Financial services
Professional and scientific
Administration and Real Estate
Government
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
0.00
IT
Source: Oxford Economics, June 2015.
Note: The forecasts should be regarded as illustrative of trends. Actual figures will differ from forecasts. Please see important
information regarding forecasts.
Furthermore, there is a possibility that the UK could leave the EU. Our assumption is that
the majority will vote to stay, rather than gamble on the unknown of an exit. In this scenario,
office occupier demand might slow in the 3–6 months leading up to the referendum, which
will probably be in 2016, but would then rally afterwards. However, if the UK did vote to leave
then it would probably hit office demand as companies which need unfettered access to the
EU (e.g. investment banks, professional services) began to re-locate some of their operations
to Dublin, Frankfurt, Paris and other European cities. That would also have a knock-on effect
on London’s residential, retail and industrial markets.
In general the outlook on the supply side is also benign (see Chart 3). In Docklands and
Mid-Town the total amount of office space is forecast to increase by only 3–4% between
2014–2019 (source: PMA) and it is actually expected to fall marginally in the West End,
as some older offices are converted to residential or hotels. The exception is the City
where developers have announced plans for a number of new towers on Bishopsgate and
Leadenhall. If three, or four of these schemes go ahead, then the total stock of office space
will increase by around 10% over the next five years. While new capital controls mean that
banks are still reluctant to fund speculative developments, other lenders such as insurers and
debt funds are starting to fill the gap.
Chart 3: Central London Office Space
Office floorspace, million sq ft
70
60
50
40
30
20
10
0
City
1990
Source: PMA, July 2015.
West End and Mid-Town
1995
2000
2005
2010
Docklands
2014
2019 Forecast
Schroder Real Estate When will Central London office rents peak?
3
If we combine the healthy prospects for employment with the generally subdued outlook
for office building, then it seems likely that Central London office rents will continue to rise
through 2016 and 2017, albeit probably at a slower rate than in 2014 and 2015. Our key
assumptions are that there are no economic shocks and that the UK stays in the EU.
What happens from 2018 is more difficult to predict, but there is a risk that the City will
start to suffer from an over-supply of office space which will depress rents. Conversely, we
believe that there are other areas which could see further rental growth through 2018–2019.
In particular, Farringdon, Stratford and Whitechapel stand to gain from the start of Crossrail
services in late 2018, while Battersea and Nine Elms should benefit from the opening of
the extension to the Northern Line underground in 2020. In addition, we think that the new
Francis Crick and Alan Turing Institutes will give further impetus to Bloomsbury and King’s
Cross and that the redevelopment of the Shell Centre and Elizabeth House could revitalise
the Waterloo office market. While new building at the macro level will tend to push rents
down, other things being equal, at the micro level it can breathe new life into an area, as
demonstrated by the positive impact of More London and The Shard on the South Bank
near London Bridge.
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