30/08/2007
London's office property market is white hot as the UK capital rides on the crest of an international finance bonanza. Are the skyrocketing rents sustainable as interest rate rises clamp down on Britain's domestic economy?
London's property market is in the grip of an extraordinary bull run as the city basks in its position as the leading financial capital in the world, fighting off New York and Frankfurt as the exchange of choice for many new listings. Add to that low levels of office supply and the financial muscle-flexing of acquisitive hedge funds and private equity houses - which are nibbling at public and private businesses around Europe - and you've got soaring rents for office property predicted to last until at least 2010.
For hedge funds, private equity and investment managers, London has now overtaken New York as the financial capital of the world,
says office research analyst Catherine Jones of King Sturge.
These companies have already made a big impact on the London market, and the increasing success of London is encouraging a second wave of financial firms to set up offices here.
Mayfair and St James's, plus the area immediately north of Oxford Street, are leading the pack in the capital, and, perhaps unsurprisingly, the area has overtaken Tokyo's inner central zone as the world's most expensive for office space.
But as other business sectors are pushed out of fashionable West End properties by the financial sector, alternative hubs are opening up around London. In July, for example, a record rent of £72.80 per metre square was achieved in Clerkenwell, the east-of-centre loft zone that took off during the dotcom boom, after DSA Engineering took 327 m2 at Redab Properties offices on the thoroughfare of Farringdon Road.
The biggest impact is being felt by companies that moved into West End offices five years ago; they face the prospect of a 60% rental hike this year. According to the latest rent review research by European property consultant Drivers Jonas, five-year-old buildings in Mayfair and St James's saw rents jump from £1,204/m2 in March 2002 to £1,565/m2 at the same time this year. Continuing rental growth in 2007 means that tenants who moved into new premises in September 2002 face a 60% increase this September.
All areas of the West End saw rental rises in the five-year period to March 2007, except Covent Garden, which remained unchanged. Rents also remained unchanged in the City and further east in London Docklands, at £960/m2 and £674/m2 respectively. According to Drivers Jonas, however, City tenants are still braced for a 15% hike in rents if they agreed to a five-yearly rent review in September 2002.
So concerned is Westminster Council, whose responsibilities encompass many of the areas most affected, that the local authority has commissioned a study by Drivers Jonas into the effects of soaring West End rents.
Westminster is investigating whether the high costs of renting commercial property in central London lower the competitiveness of the city as a commercial centre on a national and international level, and it wants to look into whether rents are being driven solely by the lack of supply attributed to historic building constraints, or whether the problem is caused by the general popularity of the area as an office location.
In January this year a record Mayfair rent of £1,926/m2 was set when Icelandic investment company FL Group agreed to the deal for the 550 m2 top floor at Grosvenor and Morley's Mayfair development, 77 Grosvenor Street. King Sturge has just amended its average estimate for prime rents in the area to £1,765/m2.
Certainly the lack of space coming to market is a big issue, and I can't see that changing until 2010,
Says Robert Leigh, director with London property services specialist Devono.
At any given time there are probably only three or four opportunities in Mayfair and St James's - it's a landlord's market.
A series of major developments will feed into the property market in 2010, when almost 400,000 m2 of new space will become available, but Leigh does not see the market cooling down until then.
The hedge funds and private equity companies can afford the astronomical rents, and they are having a ripple effect on the whole market,
he says.
Yes, interest rate rises have dented market confidence a little and have reduced potential yields, but landlords are still very bullish and I can honestly see 2008 being an even stronger year.
Jones at King Sturge agrees. "The new supply is very concentrated in certain areas, such as the City, Kings Cross and Paddington," she reflects. "The West End remains a huge draw, and it's difficult to see any end to its popularity."
With the London prime average up 7% over five years, which areas are reaping the rewards?
Skyrocketing rents are pushing traditional tenants out as hedge funds and private equity firms move in. A record rent of £1,926/m2 has been achieved this year.
Property companies pushed out of Mayfair and St James's have created a new hub here.
A traditional media hub now benefiting from the market surge, with rental values up at £1,124/ m2.
(Clerkenwell, Farringdon and Old Street) A new media hub, this former printworks area of London has one of the city's most mixed sector spreads. Rents range from £715 to £955 per m2 for secondary to prime locations.
Growth area New media companies have centred on Clerkenwell
The world's third most expensive office property area, rent increases here have been more moderate at 15% over the past five years. In the next two or three years the area will become home to some of London's new landmark skyscrapers.
This is another area benefiting from high rental rates elsewhere. More facilities are opening up, but the area is probably two or three years away from full maturity.
London's East End is at the heart of what will be the capital's main Olympic stadium and village, and despite an escalating budget the government remains confident that all sites will be cleared by the time the preceding 2008 Beijing Olympics opens. The government has pledged to pay back the ?997m of Lottery money used to cover the rising cost of the Olympics via the sale of 168 acres of development land within the Olympic Park in Stratford, east London.
Under the terms of a new memorandum drawn up following negotiations between culture secretary Tessa Jowell and London mayor Ken Livingstone, an expected £2.7bn will be raised from the sale of land.
The London Development Agency (LDA) has already spent £960m on acquiring the Olympic Park site, and the LDA estimates it will spend a further £740m on land remediation. The deal with Jowell's Department of Culture means that the Lottery will get the lion?s share of any profits first, however.
The residential element of the scheme - the Olympic Village - is being developed by Australian group Lend Lease. The company is to launch a £2.2bn residential fund called the Olympic Bond, which will probably be floated on the London stock market as a tax-efficient real estate investment trust. The fund is scheduled to be launched in 2009.
In March, a Lend Lease-led consortium including First Base and East Thames Group was named as preferred development partner for six zones of the Olympic Village, including 4,500 homes, up to 460,000 m2 of offices and almost 37,000 m2 of leisure space. During the games, athletes and officials will stay in the village's 4,000 apartments before the properties are converted into permanent housing.