Tenant Resurgence and Brexit Countdown

The robust demand in Q1 gave way to a resurgence in occupier activity in Q2, all this in the shadows of Brexit. Shaun Dawson, Head of Insights at DeVono Cresa, comments on H1 2018 and looks at the Brexit timeline.

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STEADY AND STRONG LEASING COMMITMENT

The latest data for leasing activity shows that the volume of lettings achieved in Q2 surpassed that in Q1 ensuring that the first half of 2018 was above the long-term half-year average. A number of noteworthy deals were recorded this year, not least the 589,00 sq ft Royal Mint Court scheme opposite the Tower of London scheme, taken in its entirety by the Chinese Embassy. This was the largest deal in central London since 2010, usurping more recent deals such as Deutsche Bank at Moorfields and even Bloomberg’s HQ on Cannon Street. This is not only a significant coup for the London office market but is also more indicative of commitment and investment into the UK.

Other signs of international commitment include the Japanese bank Sumitomi Mitsui Banking Corporation who pre-let over 160,000 sq ft at 100 Liverpool Street, our own client The Trade Desk pre-letting 55,000 sq ft at 1 Bartholomew Close and Canadian engineering firm SNC-Lavalin taking approximately 65,000 sq ft.

Despite this, domestic business confidence has been back and forth over the past few years as a result of referenda, general elections and the economic uncertainties. A number of surveys have indicated that confidence has been growing.

So, what is the outlook?
Business in Britain, a biannual survey by Lloyds Bank states that a net 25% of 1,500 businesses polled report an improvement in their outlook, this is up from 23% at the beginning of the year. This increase, particularly from firms that are small and medium sized, correlates with improving rise in sales. Amongst those firms surveyed, hiring intentions remain steady with 8% anticipating an increase in headcount, and there is a similar picture for capital spending too, with 12% looking to raise investment.

This nascent confidence is translating into further commitment by businesses taking office space. The volume of central London office space placed under offer at the end of Q2 2018 totalled 3.8 million sq ft, an increase of 41% on the same point last year. This suggests that annual leasing is heading in the right direction, at least to hit the long-term annual average of 11 million sq ft.

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PRIME RENTS REMAIN FAVOURABLE FOR TENANTS

Despite the dynamics of high demand and reducing levels of availability and supply, prime rental levels have generally remained the same as at the end of Q1 2018. Even looking back to the end of Q2 2017, growth over the past year has been muted, with an average uplift of 3% across all central London submarkets.

Of the rental movement that we have recorded over the past quarter, it is noteworthy that ‘core’ locations have remained static for several quarters. Canary Wharf and Paddington have seen an uplift in Prime Grade A rents by 6% and 4% respectively. Paddington rents are now at a historic high of £70.00 per sq ft, with upper floors of new buildings commanding even greater rents.

On the flip-side, locations such as Covent Garden, Knightsbridge and even Victoria have seen prime rents dip by an average of 3% over the quarter, as space continues to stick in these locations. Yet it is the locations that are piquing tenant interest, such as City fringe hotspots – Clerkenwell, Aldgate and even Hackney and London Fields – that have once again seen rental growth in both prime Grade A and Grade B stock.

These areas are expected to see further rises over the remainder of 2018, largely as a result of further demand.

The recent increase in UK interest rates from 0.5% to 0.75% (the highest level since March 2009) will have little impact on asking rents in the short-term, largely due to the composition of ownership and funding by overseas players. With just over seven months to go until Brexit, the interest rate rise will quickly become old news.

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ALL ABOARD THE BREXIT ROLLERCOASTER

Having already made the real estate market jittery for tenants and landlords, hold on to your seats, the ride is expected to get a whole lot more ‘hairy’ as it heads towards the October deadline for concluding negotiations. The UK-EU exit negotiations could easily be compared with a rollercoaster, with its ups and downs, a couple of loop-the-loops and maybe a slow stretch for quiet reflection. The great unknown is how the ride will end.

Since Article 50 was invoked in March 2017, the clock has been ticking. In order to exit the EU on the 29th March 2019 with an agreed deal, negotiations must conclude in October of this year. Whilst we have seen a number of milestones passed over the course of 2017 and 2018, the biggest task of getting a deal through the UK Parliament, the EU Parliament and ratified by every single member of the EU is a tall order.

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So, what do we know already (still proposed):

• At the point of Brexit the UK will enter a transition period until 31st December 2020
– EU Citizens to continue to enjoy freedom of movement and associated rights
– The UK can negotiate and sign its own trade deals with other countries
– The UK will still be liable to some EU laws and protocols
– Northern Ireland will remain in the single market and customs union until border issue resolved

• A temporary customs arrangement from March 2019 to December 2021
– As part of a proposed plan the UK would enter into temporary customs arrangement with the EU until the end of 2021

• A new working relationship and trade arrangement between the UK and EU starts on 1st January 2022. Despite the above positions being outlined, there is much to be revealed over the coming months that will impact businesses who currently reside and/or operate from the UK and in particular London. Whilst the European Union (withdrawal) Bill achieved Royal Assent in June 2018, and essentially converts all EU laws into UK law on the day of Brexit, the lack of clarity on issues such as banking, trading, customs arrangements and tariffs, and also the eventual immigration system is all yet to come.

The mass exodus of businesses leaving pre-Brexit has not materialised. However, the uncertainty and lack of information coming from both the UK and EU sides is causing consternation for firms trying to plan for their future and in turn planning for their space needs. As a result, companies are requiring more flexibility in what is often seen as a rigid and archaic property market. Instability and uncertainty derived from Brexit is already forcing through change. More is to come!

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For more information contact, Shaun Dawson, Head of Insights sd@devonocresa.com