West End leasing

H1 2017 take-up reached 2.35m sq ft across 226 transactions, the third highest H1 total on record and 30% above the 10-year H1 average.

Who has been driving this demand? Serviced Office Providers continue to be increasingly active in the West End and were the most active sector in H1 accounting for 27% of take-up, with WeWork accounting for 74% of this sector's activity. With several providers actively pursuing expansion opportunities and new entrants to the market such as Uncommon and Storey, we expect the sector to remain highly active in H2. Whilst the Tech & Media sector may have been displaced from the top spot, the sector continues to be highly active accounting for 25% of take-up.

Moving into H2, 1.3m sq ft of supply is currently under-offer (98% above the long term average) and we are currently tracking 5.2m sq ft of active requirements (19% above the long term average). As such, take-up looks on course to exceed the 3.9m sq ft recorded in 2016.

^{Source: Savills Research}

The West End has witnessed a gradual increase in availability in 2017, with supply at the end of H1 standing at 4.97m sq ft, equating to a vacancy rate of 4.1%. This is 20bps above the vacancy rate of 3.9% at the end of 2016, however 50bps below the longterm average of 4.6%. Looking forward, with just 370,000 sq ft of speculative completions scheduled in the first half of 2018 and 1.3m sq ft of supply currently under offer, we are likely to see a gradual reduction in availability in the remainder of 2017.

^{Source: Savills Research}

Developments

There is set to be an average of 2.1m sq ft of completions per year in the West End between 2017-2020, which is slightly ahead of the 1.8m sq ft historic average.

However, due to the constriction on supply in the West End, pre-letting has become increasingly prevalent as tenants have been forced to act early in order to secure suitable office space, particularly for larger requirements. Indeed, 34% (1.34m sq ft) of 2016's and 31% (0.74m sq ft) of H1 2017’s take-up was space pre-let before completion, while 29% of the 2017–20 pipeline has been pre-let. This trend is likely to continue, reducing the amount of speculative space being delivered to the West End market, preventing any potential over supply. Indeed, removing pre-let schemes there is set to be an average of 1.5m sq ft of speculative completions per year between 2017-20.

Rents

The West End has continued to see strong headline rental levels in 2017. There have been 27 transactions with rents above £100.00/sq ft in H1 2017 compared to 33 across 2016. These are led by a record rent of £190.00/sq ft achieved at 5 St James’s Square. Boosted by these transactions, the average prime rent at the end of Q2 2017 was £118.25/sq ft, 7% above £110.50/sq ft recorded in 2016. Similarly, the average Grade A rent has risen by 8% on last year, standing at £83.22/sq ft at the end of Q2 2017.

Whilst headline rents have held strong, the current uncertain economic climate has placed upward pressure on the level of incentives being offered to tenants. The average rent-free period on straight 10-year leases in 2017 is 20 months, compared with 16 months in 2016.

Clearly there is a limit to the amount of tenant incentives landlords can offer and it is likely that we may see downward pressure on headline rents in H2 2017 and 2018, particularly in the prime end of the market. In line with future take-up levels, the extent to which headline rents fall may be dictated by the outcome of Britain’s Brexit negotiations with the EU and the impact this has on the ability of businesses to operate in Britain and the EU. However, the West End’s broad tenant base, low vacancy rate and limited speculative development pipeline should prevent any drastic drops in rental levels.

West End investment

The West End has continued to witness high levels of investment in 2017, with turnover at the end of H1 standing at £3.90bn, just shy of the record £3.96bn recorded in H1 2015. Interestingly, whilst investment volumes in H1 2017 were the second highest ever recorded, this was spread across just 55 transactions which is the lowest number of H1 deals on record.

Turnover has remained buoyant, despite the low number of transactions. This is a result of investors targeting both scale and high quality assets, which in the main are 'well let' and in good physical condition. There has been a record six transactions over £200m up to the end of June, the same amount recorded in all of 2016. Indeed, deals of £200m or greater have totalled £1.64bn making up an unprecedented 42% of total volume compared to just 18% in 2016. This resulted in a record average deal size in H1 of £73m compared to £46m in 2016.

^{Source: Savills Research}

In terms of the sources of demand, international investors continue to dominate, accounting for 73% of investment volumes. Asian investors have been particularly active in the first half of the year making up 38% of total volumes, while European investors have accounted for 27%. UK investors are still active; albeit in the main for smaller assets. Whilst investors from the UK transacted on 24 properties, the average deal size was £44m compared to £134m to Asian investors. We have seen little activity from Middle Eastern and US investors so far this year with purchasers from these regions accounting for just 5% and 1% of turnover respectively.

Unsurprisingly, strong overseas demand has resulted in the sales market being dominated by domestic sellers (80%) with UK institutions alone accounting for over a quarter of all sales. This has been a continuing trend over the last three years with the total net disinvestment from this category of investor in excess of £4bn since 2015. We expect the continuation of this theme as long as current market conditions prevail.

^{Source: Savills Research}

Yields

In the immediate aftermath of the EU referendum we moved the Savills prime hypothetical yield out 25bps to 3.50%. However, strong investor demand led us to move the yield back down to 3.25% in November 2016 and it remains at this level at the end of H1 2017. This low yield is supported by further compression of the IPD average equivalent yield to 4.70%, down from 4.78% at the beginning of the year.

Outlook

We believe we are set to witness a continuation of current market conditions in the second half of 2017, with strong buyer demand. International investors will remain dominant as they continue to be drawn to the market by the discount offered by the depreciation of sterling and the secure income that Central London property can provide.

Well let 'trophy' assets will continue to have particularly high levels of demand and ensure the average deal size remains at a record level. The continuation of this trend is placing further downward pressure on prime yields which could lead to further hardening in H2. The leasing market's current resilience and diversity will also ensure West End property remains attractive to investors.

Investment volumes at the end of H1 are well on course to exceed the 10-year annual average of £6.4bn. Looking to the second half of the year, with demand levels persisting and many large sales pending, we expect to see similar investment volumes in H2 2017.