Figure 1: Relationship between Vacancy Rates and Rental Levels in Mayfair
£ per sq ( Vacancy Rate Vacancy Rate Prime Rent
But the tale is more complicated than a pure comparison of vacancy
rates versus headline rents. In truth, it’s all about the relative quality
of vacant space. Grade A product remains sought after across the
entire Central London office market. Buildings make a resounding
statement about the occupiers and their corporate message, professionalism and ambition. Not only are there issues of perception
but retention of skilled staff and key fee earners are also closely
linked to quality of the work environment as well as remuneration.
Human resource remains the most onerous expense on any company balance sheet and failure to address issues of staff retention
can be costly and ultimately highly beneficial to the competition.
If two identical companies have an available position, yet only
one has high quality office environment in a desirable and accessible location, then it is likely that the recruit will favour the company who occupies good quality office space on the grounds of a
superior working environment. Staff retention is a key concern to
employers. Recent studies by Accenture suggest that losing a staff
member costs between 0.8 and 1. 8 times the employee’s salary.
Space constraints remain to the fore though. The West End is
not a homogeneous market; a number of sub-markets display differing characteristics in terms of bias to toward certain business
sectors, their requirements and rents paid. Overall, office stock has
remained flat over the past decade with the particularly low level
of net additions in the West End. This is primarily the result of the
tight local planning regime, which is characterized by a large number of conservation areas and listed buildings. This is especially
evident in the West End core submarket of Mayfair, where building
activity is usually refurbishment, while in non-core areas, restrictions on development are more relaxed, and large new buildings
can be more readily added to the stock. Other reasons for the lack
of growth in office space include the complex land ownership and
the growing reversion of office space to residential use.
Ultimately, top quality space costs and London is where you
start paying. In London, vacant office space of Grade A+ quality is
decreasing as much through lack of new supply as demand. Grade
A demand is driving positive absorption in the City of London
market (see Figure 2). More critically, the uptake of Grade A space
is shifting in terms of relative quality.
The most active sector of the Grade A market during 2010 was
the A- category. While the potential shortage of built Grade A+
space continues to dominate the headlines, occupiers have been
snapping up lower profile space across the entire City market.
Demand for A- space has been driven by a number of factors.
Value for money is a major contributor with average A- rents at
close to £ 40 psf. This figure compares to a City headline rental
level of £ 57. 50 psf, which rose by 28 percent during the course
of 2010. Additionally, occupiers are keen to secure space at less
sq $ All Grades Grade A
Figure 2: Net Stock Absorption in City of London Office Market by Grade
inflated rental levels also being prepared to prioritise location over
build quality. As A- space begins to be absorbed, we will see occupiers being forced to look at better quality Grade A and A+ space
in order to satisfy their needs.
As always, it boils down to supply and demand. Everyone wants
to be at the party and ensure they are noticed. Everyone wants the
‘access-all-area’ pass to the most exclusive venues but still wants
it at the right price. Shortage of ‘prestige’ new development space
is set to be the key driver of further rental uplift into 2012. It’s a
similar story in New York where estimates suggest there were 19
deals of $100 psf plus for tower space during 2010. Agents are
confident that the equivalent figure for 2011 should be more than
double that. The higher the floor, the higher the rent, and the Plaza
district in Manhattan is leading the charge.
As in London, ‘trophy’ space is being eroded with little new
product on the horizon. Occupiers tend to have fairly short memories, but even they can remember the steamier rentals being
attained in 2008. Equivalent deals for tower space were achieving
up to $180 psf making current quoting rents look relatively good
value. Those with lease expires imminent will be happy to sign up
at such levels anticipating sharper rental uplift over the next 18
months. For once, London and New York seem to be singing from
the same hymn sheet without the former being a couple of verses
behind. There are likely to be an increasing number of ‘eyes on the
prize’ of the trophy assets, as vacancy rates start to tumble further.
Landlords are under starters orders to begin tightening up incentive packages. In addition, strategic marketing plans for the key
trophy assets should enable developers to offload the prime floor
plates at or close to the peak of the rental growth cycle, thus harnessing established rental uplift and market conditions in order to
elevate the value of their own product.
Contrary to popular perceived wisdom, in the current cycle,
London does not have a limitless supply of brand new, shiny office
space. Funding constraints have served to limit supply dramatically. Ironically, it is that constraint that looks set to launch the
next wave of development, as major pre-letting agreements from
occupiers unable to secure built space, help to kick start stalled or
potential projects. Aon has just signed for 191,000 sq ft at British
Land’s 45 storey tower in the heart of the City.
The cosmopolitan caché of London remains. It is still very much
one of the key global centres for business and commerce. A place
to be seen in or more importantly a place to avoid exclusion from.
To what extent the shift in global commercial power bases will
undermine its position going forward, is open to debate, but supply
issues, coupled with inherent property outlay and competition for
product are set to maintain the upward momentum in occupational
costs, for the time being at least.