Lease lengths shorten for first time since 2011

Andy Martin - Chief Executive Officer - BNP Paribas Real Estate Advisory UK

MSCI Inc. (NYSE: MSCI), a leading provider of research-based indexes and analytics, has released its latest research on UK property leasing trends with the publication of the UK Lease Events Review 2017.

The market-leading research, sponsored by BNP Paribas Real Estate and the British Property Federation, reported that new property lease lengths average 7.1 years in 2017, a small decline of 0.1 year compared to 2016. This ended the steady upward trend in lease lengths seen since 2011.

This year’s reversal in the trend toward longer leases reflected a continued increase in the prevalence of medium leases (5-9 years), now coupled with a decline in the share of long leases (greater than 10 years) rather than the decline in short leases (0-4 years) seen in recent years.

Break clauses have continued to grow in use across new leases of all lengths, and are now included in just over 40% of leases. They are most common in industrial leases and least common for offices. But while the number of tenants taking break clauses is rising, they are exercised relatively infrequently, only 32% of the time.

At lease expiry, just 31% of tenants chose to renew their leases. With only 17% relet to new tenants, 52% of units remained vacant immediately after expiry. Retail units saw a lower vacancy rate after expiry (46%), but nearly two-thirds of office units became vacant. However, for those units that were immediately relet, offices achieved higher rents in 75% of cases, while retail rents fell 58% of the time.

The steady decline in tenant default rates seen since 2012 continued into 2016, although they remained marginally higher than pre-financial crisis levels. While there was continued convergence across the major property sectors, there were contrasts within retails. The lowest default rates were in the Standard Retail – Rest of UK segment at 1.9% of rent passing, the highest in Shopping Centres at 5.4%.

Will Robson, Executive Director, MSCI, said: “The first study results since the referendum appear to paint a picture of slightly greater caution on the part of tenants. The trend toward lengthening leases has come to an end, driven by tenants’ reticence to sign the longest of leases in favour of those between 5 and 9 years.”

Andy Martin, Chief Executive Officer, BNP Paribas Real Estate UK, said: “Although average lease lengths have shortened considerably since the 1980s and 90s, recent years have provided some relief to investors with lease lengths remaining relatively stable. However, with the clock ticking down to the UK’s exit from the European Union, and with new lease accounting regulations to come in to force, we may see occupiers seeking greater flexibility over the next 12 months.

“In the office sector, for example, serviced offices and co-working providers are becoming a significant part of the market, taking long leases from landlords and picking up the rental premium for leasing out and managing short-term space. We expect the major institutional investors increasingly to respond by developing their own flexible space platforms to cater for this demand.”

Ian Fletcher, Director of Real Estate Policy, British Property Federation, said: “The survey suggests occupiers remain cautious, but slightly more confident to take on commitments, with the most popular form of new lease lasting 5-9 years, probably with a break, rather than the short leases which have characterised the last few years.

“One of the most striking statistics in this year’s report is that 50% of property remains vacant when a lease expires. It illustrates how important it is that policy (both at local and national Government level) allows the real economy to adapt to changing circumstances, promoting easy access to leasing, or redevelopment, if that is what is required.”

The MSCI Lease Events Review for 2016 and year to June 2017 provides empirical evidence on the likelihood of the different types of lease events for office, retail and industrial leases. The analysis is based on a sample of over 75,000 extant leases held in the IPD UK Annual and Quarterly Property Universe, and more than 8,200 new leases signed over the last year.

The report examines the influence of three key lease events on the property investment market; lease expiries, break clauses and lease renewal. Each of these events is intrinsically linked to the broader economic landscape and improvements in business activity, exports and consumer trends, all of which have a direct effect on lease conditions.