Savills City Office Market Watch: Rental falls expected in H2 before rebounding next year

Savills has released its latest monthly report looking at the City occupational markets:

Encouragingly June saw an increase in leasing activity with 242,998 sq ft of take-up in the City, bringing the total for the year to date to 1.84m sq ft, which is 28% down on this point last year and 36% down on the 10-year average for the first half. The 12-month rolling take-up is now at 6.1m sq ft, which is 6% down on the 10-year average.

The largest deal to complete last month saw Arcadis acquire levels five and six (40,654 sq ft) at Eighty Fen, 80 Fenchurch Street, EC3 on a 15-year lease at £69.00/sq ft with 27 months rent free. The Partners/YardNine scheme recently achieved practical completion and is now 44% let with 135,000 sq ft remaining available.

Also last month, we saw Avenir Global acquire levels 5 and 6 (34,791 sq ft) at Riverside House, 2a Southwark Bridge Road, SE1 on a straight 10-year lease at £70.00/sq ft. The Montreal-based holding and management company will be moving from their current space in 160 Blackfriars Road, SE1. There is now just 38,468 sq ft remaining available across levels 7–9 and 11.

The Professional Services sector continues to account for the majority of take-up with a 31% share at the end of H1. They are followed by the Tech & Media sector and the Insurance & Financial Services sector at 23% and 15% respectively. Interestingly, the Serviced Office Provider sector has only accounted for 3% of take-up so far this year equating to just 62,593 sq ft, down on the 555,676 sq ft they had transacted by this point last year.

At the end of Q2 2020 there is currently 7.8m sq ft of available supply, equating to a vacancy rate of 5.7%, which is up on Q2 last year by 70bps but down on the long-term average of 6.6%. This is also the 69th consecutive month of the vacancy rate being sub 6%. Currently, 81% of supply is of a Grade A standard, which is down on the five-year average of 84%. The majority of supply (57%) is within the City core, and therefore has a higher vacancy rate of 6.9%, compared with just 4.9% in the fringes.

It seems likely that supply in the City will begin to rise over the next 12 months due to Covid-19. Currently, tenant controlled space accounts for 30% of available supply, which is up on the five-year average of 24%, however, it is likely that this will continue to increase due to the impact of the pandemic on unemployment and occupiers reassessing their office requirements, although to what extent remains unclear. Since the start of lockdown in mid-March we have seen 1m sq ft of tenant supply arrive to the market, however circa half of this was already planned to be brought to the market anyway. The sectors that have accounted for the greatest proportion of tenant supply so far have been the Insurance & Financial services sector at 16%, the Tech & Media sector at 15%, and the Banking sector at 15%.

We are forecasting the City vacancy rate to reach 6.5% by the year-end, just 10bps below the long-term average. We are then expecting this to reach a high of 8.0% by the end of 2022 before falling to 7.3% by the end of 2024.

At the end of H1 this year, the current average prime rent is £81.80/sq ft, which is up on last year by 1.4%. Meanwhile, the average Grade A rent has settled at £66.49/sq ft, which is also up on last year by 3.0%, although this is still only analysing a small number of deals, and we are expecting the rental falls to come in the second half of the year.

We are forecasting Q4 2020 average prime rents to fall by 7.1% in comparison with Q4 2019. These are then expected to rebound next year with a 6.6% increase. On average we are forecasting 2.5% per annum increases for average prime rents over the next five years.