Occupier update - "Willing but Able?"

5th October 2017
Occupier update - "Willing but Able?"

In this update, Newton Perkins partner Ian Sonnenthal, looks at the City office market and assesses how occupiers can negotiate great deals (with Newton Perkins help!) considering the current market conditions.  

“Let’s start by looking at what has been happening in the market.  

After a sustained strong run of UK economic growth, the pace of expansion has unsurprisingly moderated in the first half of 2017 following Brexit and recent political uncertainty.  The recent rise in inflation and a series of base rate hikes by the Federal reserve in the United States has prompted a debate about whether the Bank of England should also begin to raise rates.  This appears unlikely in the near term, although long term interest rates have lifted slightly as some market participants have reacted to this debate.  

However, against this difficult back drop, central London office take up volumes improved in Q2 of 2017, reaching 1.6 million sq.ft in 87 transactions, which brings take up at the half year point to 2.8 million sq.ft.  This is a stronger start to the year than 2016 and ahead of the 10 year average.  

We have witnessed some notable transactions in recent months, such as a Deutsche Bank’s pre-let of the entirety of the future scheme at 21 Moorfields, EC2 which is c.570,000 sq.ft.  Furthermore, NEX Group Plc leased 120,000 sq.ft at the London Fruit and Wool Exchange, E1.  

So far this year, the TMT sector has accounted for the greatest proportion of take up at 21%.  This is followed by the banking sector, largely due to Deutsche Bank, now accounting for 15%. The professional services sector are next at 14% and the insurance and financial services sector at 10%.  There has been continued strong activity from serviced office providers who have accounted for 7% of take up to date.  

However, contrary to the large headline deals being reported, Newton Perkins research has revealed that supply levels are at an increasingly high level. Perhaps not so prevalent in the new build/tower market  (in which supply in the first half of 2017 fell marginally to a very low vacancy rate of 0.9%) but in the second hand and refurbished sector which has increased by 3% to 4.3 million sq.ft and accounts for 81% of overall supply.  

This high level of refurbished or second hand stock is pertinent to us at Newton Perkins as we believe that market figures have been skewed by headline grabbing deals such as Deutsche Bank.  In reality, the high levels of supply (especially in the sub 20,000 sq.ft market) suggests we are witnessing a shift towards a tenants market.  

So what does this mean for occupiers? Occupiers needing new offices are starting to be met by a never ending list of available properties and inducements, and there are certainly opportunities for the “willing and able” occupier.  

For the “willing” occupier (i.e. with no existing premises to get rid of) the basket of inducements can still include dealing rents lower than quoting levels, inducement packages (offering c. 2 – 2.5 months’ rent free for each year of occupation) and/or lease flexibility to break in, say 3 or 5 years.  For companies boasting a strong balance sheet, some landlords will still offer to fund fit-out costs with minimal requirements for security deposits.  The city of London also continues to offer the lowest central London outgoings as compared with the West End and mid-town equivalents.  

However, it is not all roses.  Many occupiers are not able to capitalise on the opportunities as they are tied into lease obligations with little or no chance of surrendering. The option is to re-let unwanted accommodation and become an accidental landlord but this path requires the offer of similar inducements in order to attract new tenants.  To add pain, the government’s change of policy on rates relief for unused or empty property has doubled the holding costs.  

All is not lost however.  Over the past 10 years many UK companies have moved to shorter term leases or have break options.  Landlords faced with the fear of having an empty property will still offer reasonable rent free periods and renegotiated lease terms in order to extend the stay of their existing tenants.  However, many occupiers fail to appreciate the opportunity and the strength of their negotiating position or simply leave it too late to start the discussion.  

For companies requiring less than 10,000 sq.ft, a 9-12 month head start is usually needed before lease expiry or break option in order for constructive discussions to take place with the landlord.  Larger companies generally require a longer leading time and we recommend up to 18 months ahead.  

So our advice is that occupiers should take an active look at their lease, break options and opportunities to move and/or restructure leases.  They should seek to exploit the opportunities presented by the current market…where they are “willing and able” to do so.”


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