Development completions are set to hit a peak this year whilst new starts show little sign of a significant fall
So far this year, we have continued to see high levels of pent up demand as many occupiers have continued to adopt a ‘wait and see’ approach with their future office requirements. As a result, active Central London requirements currently stand at 10m sq ft, up 41% on the same period last year.
Almost half of the overall quantum of this space is made up of occupiers with lease events into 2023 and beyond, giving strong indication we will continue to see occupiers considering pipeline options.
The continuation of strong demand for newly developed or extensively refurbished space has resulted in pre-lets accounting for 22% of space acquired since the first lockdown in March 2020.
The increased polarization between best-in-class space and Grade B space is further illustrated by the fact that 88% of leasing activity over this period has been of Grade A standard.
Whilst there is still much debate about the longer-term impact that hybrid models of working may have on office demand, almost half of the pre-lets that have been exchanged this year are at least two years ahead of their scheduled completion, illustrating the continued importance occupiers attach to the office.
This strong appetite for newly developed product has led to high levels of developer confidence in recent years, and we are expecting development completions for this year to hit a three-year high, with 5.5m sq ft scheduled for delivery by the end of this year. Most notably, development completions in the West End are set to reach their highest level on record, with 3.4m sq ft currently forecasted.
Due to the prevalence of pre-letting activity, 42% of this year’s deliveries have been let prior to completion. Notable completions this year include Battersea Power Station, SW8 (550,000 sq ft), 1 Portsoken Yard, E1 (233,000 sq ft) and 2 Gresham Street EC2, (180,459 sq ft).
In total, 17% of the 31m sq ft of the extensive refurbishments and new developments scheduled for completion over the next five years have so far been pre-let.
Peak levels of annual completions are expected over the next three years, with a record level of 7.4m sq ft currently scheduled for delivery in 2023, and a similar level anticipated for 2024. Although, there are pricing headwinds ahead, particularly with rising building costs as a result of increased pricing on raw materials and productivity levels. This will likely temper overall development completions over the next few years.
The BCIS is currently forecasting building costs across the board will rise on average by 2.7% per annum between 2021 and 2025. This along with the typical planning and construction delays will further reduce any potential risks of oversupply despite the peak levels of activity anticipated.
Continued developer confidence in the Central London office market is further illustrated by the lack of a significant slump to development starts for this year, in contrast with previous downturns. New starts are expected to be down by just 9% on the average annual level of starts we have seen over the past five years.
We are currently anticipating around 6.3m sq ft of new developments, and extensive refurbishments will start by the end of this year. This is up 5% on 2020, where development starts were down 17% on 2019.
Almost two thirds (65%) of schemes starting this year are extensive refurbishments, the majority of which are set to complete by the end of 2022.
The City Fringe sub-market accounts for 29% of this year’s new starts, followed by the City Core with 24%, and then by SE1 with 11%.
Over the past decade, prior to Covid-19, the average annual Grade A take-up was typically around 8.4m sq ft. Accounting for a 15% reduction as a result of the fall in the demand for office space we could potentially see, if we were to see similar levels of demand for this type of product return, this would equate to just over 7m sq ft of annual demand for Grade A space.
At this rate of take-up, the entire speculative pipeline for the next five years equates to around 43 months of supply indicating that if similar levels of demand were to return the potential risk of oversupply of this type of product would be limited.
There has been an increasing focus on the need to reduce the environmental footprint of commercial developments over recent years, which has been intensified by Covid-19. This focus on sustainability credentials has been driven by planning policies and changing expectations across the board from investors and occupiers.
Around 44% of this year's new starts are known to be aiming to achieve a BREEAM rating of Very Good or above.
While the vast majority of schemes starting this year are speculative, when you look at the space that has already been pre-let, a stronger preference for space in buildings with good sustainability credentials is reflected by the fact that 82% of new starts (that have already been pre-let) are targeting a BREEAM rating of Very Good or above.
At present, only 10% of schemes scheduled for delivery over the next five years are currently targeting a BREEAM rating of Outstanding; a further 26% are targeting Excellent, and 3% are targeting Very Good.
Over half of the schemes that will be delivered over this period that are targeting a rating of Outstanding or Excellent are in either the City Core or City Fringe; 17% are in SE1, and collectively, West End sub-markets account for 30% of this total.
Around 67% of schemes targeting a rating of Excellent or above are new developments, (as opposed to extensive refurbishments). This reflects the balancing act being struck between sustainability considerations (for example, retaining the embodied carbon) and maximising the scheme/site coverage.
As more and more businesses (including investors and occupiers) set their own net zero carbon targets and consider their wider sustainability objectives, there is increasing incentives for occupiers to consider how these objectives can be achieved through their real estate decisions, for example, by targeting office schemes with measures that can reduce/eliminate emissions.
Around 45% (14.3m sq ft) of take-up since 2018 has been in space with a BREEAM rating of Excellent or above. At present, just 11m sq ft of speculatively available schemes in the pipeline are targeting a rating of Excellent or Outstanding, which equates to 44% of all speculative deliveries. This indicates that future supply of this type of product will most likely be outpaced by demand.
Going beyond…
Areas with good public realm offerings, strong transport links or that have future infrastructure improvement plans, for example, Victoria, Farringdon, Clerkenwell, King’s Cross and White City have benefited from this in the past, and it has helped these areas attract strong levels of demand from increasingly footloose occupiers. They also rank high in terms of retaining their existing tenant base.
Additionally, we have seen clear evidence on the post-delivery success of areas that have delivered on creating a place versus those that have not. The integration of ESG considerations will continue to make all aspects of placemaking, an increasingly important complement for Central London offices.
Areas that have successfully been able to deliver on placemaking have been able to create more vibrant locations which attract occupiers and could act as an incentive to bring workers into the office, as well as helping towards establishing a community feel.
The digital aspects of placemaking, like branding and communication, also play a crucial role in successful delivery. "Digital placemaking is particularly crucial for mixed-use schemes for bringing people together across the different uses and also with the wider community, which is a positive for long-term success," says Katy Warrick, Residential Research Director.
Prior to Covid-19, our 'What Workers Want' survey already revealed London workers were most dissatisfied with the provision of social meeting spaces and outside buildings space (e.g. access to roof terraces, gardens and green spaces), and that easier wins could be gained with improvements to things like air quality and lighting.
Well-placed, good-quality mixed-use developments that are well-balanced have the benefit of being supported by more community-related elements, as well as attracting the additional varied footfall from the different complementary uses and have been demonstrated to attract premiums.
The recent change in approach in the office sector to a more user/customer-focused approach has increased the importance of having early vision and clear strategy.