Upward pressure on prime rents was mounting ahead of Q1 2020. Our research suggests that this has not materialised – with only two instances of Prime Grade B rental increases (Mayfair & Aldgate). Overall, this represents an average rental growth of 0% across central London submarkets. Whilst the lower demand compared with previous quarters was a factor in this, it has been the reduced level of leasing activity on prime space and fewer deals transacted in March that has ensured previous rental growth came to a halt.

Whilst several leasing transactions continued to proceed; the office market was effectively put on ice in mid-March. Market fundamentals of demand, supply and rents have gone into lockdown too. The current situation will no doubt significantly dampen demand in the short-to-medium term. We do expect it to return, not least of all because our research shows that between June 2020 and December 2021, there are approximately 1,500 tenants in over 10 million sq ft of office space across central London that have leases due to expire. There is no expectation that these will all translate into new leases as some will renew for ease of continuity, or even just extend in the short-term. However, there will be some who will take this opportunity to re-evaluate their office space – whether the size, location or even the type of space, leasehold or flexible. 

photo

As businesses prepare to make future plans, most will have become increasingly cost prudent compared with a few weeks ago. The current situation where businesses have paid rents and rates on empty office space will have certainly focused a few CFOs and FDs into giving greater scrutiny to the cost of the office. With the rental level being one of the main drivers of leasing decisions, is it too early to have visibility of where rents might be heading?

HISTORICAL CONTEXT?

In short, yes. The current situation we find ourselves is unparalleled both in its scale and nature. Trying to gauge the impact of a global lockdown and as yet unmeasurable economic downturn on the rental tone is made all the more difficult when there is no comparative data. The closest scenario is that of previous downturns, the most significant of which is the Global Financial Crisis (GFC). Nevertheless, whilst this event had a major impact on the UK economy, it did so with a relatively protracted lead in time, which slowly filtered through to the office market. 

Our data series shows that prime rents in the core markets of the West End and the City contracted in Q2 2008 during the GFC. This followed six months of no rental growth whilst the financial turmoil spread around the world. And, even then the decrease was comparatively low with a drop of 8% and 4% respectively in each market. A significant price correction downwards occurred at the start of 2009, when the true extent of the banking crisis hit the economy, jobs and spending. The situation we find ourselves in today is that we have not had the luxury of a lead-in to this crisis and as such, any comparison must be viewed with a heavy dose of caution.

The events of the GFC led to a rental decline over two years, with prime rents taking a further five years to get back to the previous level. Whilst a similar scenario cannot be ruled out, there are several factors that suggest the level of rental decline could be different:

• Shutdown of the leasing market and no activity – no budge in immediate rental expectation
• Significant government support given to all businesses to maintain employment and cash-flow
• Financial industry support with loans and payment holidays
• A low level of office availability and below-average level of Grade A office supply across central London
• Pre-COVID-19 office demand deferment - but not disappeared

Market inactivity during Q2 is likely to ensure that we will see another quarter of no rental growth. Thereafter, we could envisage some declines, dependant on the speed and route out of lockdown. Whilst a return to normality as we once knew seems a long way off, landlords and real estate professionals will hold on as long as possible to fully appreciate the leasing landscape before considering reducing rents. Negotiations in the short-term will likely lead to improved incentive packages or the deferring of start dates.