City leasing

H1 2017 take-up reached 3.2m sq ft, of which 80% was of a grade A standard. This is 19% up on this point last year, and 20% above the 10-year H1 average.

Traditionally, the Insurance & Financial services sector has accounted for the majority of take-up in the City, although this appears to be changing, with these sectors only accounting for 13% of take-up so far this year.

The highest demand has come from the Tech & Media sector who have accounted for 24% of take-up. Significant deals from Framestore at 28 Chancery Lane (94,000 sq ft) and ITV at 2 Waterhouse Square (89,000 sq ft) have contributed to the lion’s share.

There has been consistent activity from the Professional services sector which has accounted for 16% of take-up, although this has been considerably aided by Freshfields Bruckhaus Deringer LLP acquiring 288,000 sq ft at 100 Bishopsgate. Serviced Office Providers have continued to acquire space in the City this year, accounting for 8% of take-up, with WeWork sourcing a new centre at Mark Square House, EC2 (70,000 sq ft).

^{Source: Savills Research}

At the end of Q2, there was 1.8m sq ft under-offer which is up on the long-term average by 39%, giving a good indication that we will see the high level of take-up continue for the remainder of the year. Especially, as we are now aware that circa 564,000 sq ft of the 1.8m sq ft under-offer has since completed in one deal which saw Deutsche Bank commit to a new HQ at 21 Moorfields.

Due to an active first half of above average take-up, we did not see an increase in the vacancy rate at the end of Q2. There is currently 6.9m sq ft of available supply, equating to a vacancy rate of 5.6%, which is up on this point last year by just 40bps, and 100bps below the 10-year average.

Looking forward, with 1.5m sq ft of speculative completions scheduled to arrive in the first half of 2018, we would anticipate the vacancy rate to gently rise over the next 12 months.

^{Source: Savills Research}

Developments

From 2017 there are currently only two years of above average completions expected to arrive within the City, with the greatest amount anticipated for 2018 at a total of 5.8m sq ft of which 3.1m sq ft is already prelet. In fact, 31% of the 10.6m sq ft expected to arrive between 2018–20 is already pre-let, a trend which we expect to continue as larger occupiers are forced to look into the future to guarantee their property requirements are successfully satisfied.

Rents

At the end of H1, the average prime rent in the City is £74.50/sq ft, which is down on 2016 by 4%, but up on the 10-year average by 22%. Similarly, the average Grade A rent slightly dipped in H1 at £59.75/sq ft, falling by 3% on 2016, however it is still up on the 10-year average by 22%.

Furthermore, we have also seen the gap between the average Grade A rent in the City Fringe and the City Core narrow. In 2012, the difference between the two sub-markets was £9.98/sq ft, and this has narrowed to just £0.35/sq ft at the end of H1 2017. Current City Core average Grade A rent is £60.24/sq ft while the City Fringe is £59.89/ sq ft. This has been a result of new Grade A developments in the fringe locations, coupled with more 'footloose' occupiers being present in the market who now see these fringe locations as suitable and attractive destinations.

We have also witnessed an increase in the level of incentives being offered in the City. The average rent-free period on a straight 10-year lease in 2017 is 22 months, compared with 17 months in 2016. Historically, we have found once incentives reach approximately 24 months rent free, headline rents will begin to fall.

City investment

The City has seen above average levels of investment so far this year, with turnover reaching £4.98bn in the first half, which is up on this point last year by 17% and 30% up on the 10-year average for H1.

There has been a trend for larger ‘trophy’ assets as even though turnover is up on this point last year, there has only been 64 transactions in H1 compared with 85 over the same period last year. This is further evident by the ten largest deals so far this year totalling £3.4bn, compared with the ten largest across the whole of 2016 totalling £3.1bn. With more trophy assets expected to be traded in the second half of the year, it is almost certain this gap will widen and therefore likely total turnover will surpass that of 2016.

^{Source: Savills Research}

Similar to the West End, international investors have accounted for the majority of investment this year accounting for 84% of turnover. Asian investors have continued to be a prominent source of this foreign investment, as they accounted for 50% of total City turnover for H1. The continued weakness of Sterling, combined with the activity of new entrants and their desire to diversify out of their domestic market, has resulted in Asian investors flooding central London.

European purchasers have also been attracted to City properties as they accounted for 25% of turnover in H1. German funds have been responsible for almost the entirety of the mainland European investment, attracted by high quality real estate and attractive risk adjusted returns on a pan European basis.

Investors from the UK have accounted for 28 of the 64 transactions, however they have only accounted for 16% of turnover, showing their appetite has been for the smaller lot sizes. As with the West End, activity from the US and the Middle East remains relatively muted as they both have only accounted for 4% of total turnover.

^{Source: Savills Research}

Yields

Following the referendum, we saw yields in the City move out 25bps as they reached 4.25% at this point last year. However, that has been the ceiling for City so far in this cycle as in February of this year we saw them harden back to 4.00% following the steady stream of foreign investment paying sub 4.00% for some trophy assets.

Outlook

Currently there is strong demand from overseas investors for good quality City assets. In particular, we have seen a great deal of focus on some high profile trophy asset purchases, such as the Leadenhall Building and 20 Fenchurch Street, at historically low yields. Away from those headline grabbing deals we have experienced a consistent level of demand for more generic stock although the pricing and yields have been more consistent with the past 18 months pricing levels.

There has been significant activity from overseas, and in particular from Asian investors, and undoubtedly the recent announcement of further restrictions being imposed on the outflow of capital from China will have a knock-on effect on some of this appetite. This may well have an impact on pricing for some assets, however there is also a healthy level of interest from other international buyers, most notably form Europe and the Middle East, which will continue to create competition for this Asian capital.

Unless we see a market deterioration in the leasing market and real rental falls, we expect international investors to continue to find City office investments attractive.