What are the current office take-up trends?
The messages on tenant office demand and leasing activity trends are mixed. Take-up is down 10-15% on average levels, although this probably has as much to do with the economy and occupier uncertainty as it does with agile working. Demand levels in central London are 41% above their long-term average, with 49% of the companies currently searching for space looking for more than they occupy at the moment (17% are looking to downsize).
Growth is being driven by corporate growth expectations, and overall demand remains highly biased towards prime (typically more than 70% of central London take-up is Grade A). The definition of prime now clearly includes the carbon efficiency of the building, with energy performance certificate (EPC) and BREEAM grading being important for both lettability and the likelihood of achieving top decile rents.
Limited levels of development activity since 2019 – reduced by Covid-19 and then the rising cost of debt – mean prime office rents in London have risen more strongly than ever through an economic downturn (6.3% per annum in the West End and 4.1% per annum in the City). Tenants are clearly comfortable with paying this for the right building in the right location, but Grade B rents have been falling since 2020.
How is the upgrade to green standards progressing?
The UK minimum energy efficiency standard (MEES) regulations for non-domestic buildings were updated in April 2023. With some exceptions, properties with an EPC rating of F or G can no longer be leased. In 2021 the UK government issued a consultation on expanding the MEES regulations so that the minimum EPC rating rises to C in 2027, and B in 2030. These changes have not been implemented or made policy yet, but most of the major commercial property landlords in London and the rest of the UK are working on the assumption that they will be, for refurbishments and developments.
There have been some indications that local planning policy in London is becoming increasingly anti-demolition and rebuild because of the embodied carbon expended in the process. However, as yet, no specific policy exists around embodied carbon monitoring or management in the UK. We expect that in the medium to long-term we will see an increasing bias towards refurbishment over redevelopment, although there will always be situations where demolition is the only choice.
What has been the impact of hybrid working on the market?
Markets where company size is smaller, such as the West End, are averaging over 60% occupancy – very close to pre-Covid levels – while the City of London, with its larger tenants, is averaging just over 50%. The UK has very low unemployment levels and high transport costs, so we don’t expect occupancy levels to revert to pre-Covid highs. In fact, a slightly lower utilisation rate is good for staff and occupiers, enhancing wellness and happiness, in comparison to pre-Covid years when surveys suggested that occupational densities had gone too high.
How are demand and supply dynamics likely to evolve over the next decade?
Modest employment growth, falling occupational densities, lower than normal levels of development starts and corporate decarbonisation strategies are all more than compensating for lower utilisation rates in the central London office market.
A shortage of prime and green offices is expected to drive higher than normal prime rental growth for the next five years. This in turn will make speculative development more viable and lead to a pick up in development starts (and hence completions in the early 2030s). This will slow rental growth on prime property and accelerate the upgrading of Grade B to Grade A.
We are already seeing slightly higher than normal levels of office conversions, with hotels and labs being more common than residential this cycle. In the medium term we do not believe the predicted repurposing rate for central London offices will present a significant challenge to landlords, with the majority of technically obsolete office space just being refurbished or redeveloped into lettable offices.
What are the challenges and opportunities in the repurposing process?
Planning policy has been amended to make it easier to go from office use to residential, although in the context of central London this is not particularly common at the moment. London has a particularly high proportion of historic buildings, which, in some cases, are exempt from MEES regulations, and also present greater challenges in terms of improvement or change of use. However, many of these have transitioned from residential to commercial uses and back again over hundreds of years, so the challenge is seldom insurmountable.
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