Insight 2:

What Drives Leasing

Out-Performance?

The London market has become increasingly polarised. The prime market is seeing heightened levels of demand, a deepening imbalance between supply and demand and, as a consequence, further upwards pressure on rents.

To download the full insight article click on the button below.

The pandemic experience has acted as a fork in the road as occupier demand has increasingly favoured new and refurbished offices, with lettings in this part of the market increasing 28% since 2020. In contrast, lettings of secondary offices have fallen by 44% over the same period. We have examined post-pandemic leasing transactions and identified two key factors that have driven the out-performance of new and refurbished offices:

Sustainability - the take-up of offices with a BREEAM certification and an Energy Performance Certificate (EPC) rating of A-C are both at the highest levels for over five years in London. Last year 62% of new and refurbished lettings were for offices with the highest certifications of 'Outstanding' and 'Excellent'.

Amenity Provision – our analysis of post-pandemic lettings shows almost all new and refurbished buildings have end-of-trip facilities such as cycle rack, showers and lockers but the essential differentiator of best-in-class offices is in the quality of the in-building amenity offer e.g. terrace floors, green space, wellness facilities, flexible office provision, F&B offering. Lettings of offices with these quality characteristics have seen stronger rental growth compared with offices with just end-of-trip facilities.

Historically, a growing economy plays a key role in driving performance of London offices, however, there has been a decoupling of demand from wider economic trends, with occupiers using real estate as a strategic devise to drive performance. Our analysis of leasing transactions since 2021, shows there has been positive net absorption of office space, which has been a key ingredient for rental growth, and this has been evident for prime offices in many London submarkets. We have also analysed current named requirements over 50,000 sq ft and expect positive net absorption to remain a key feature in London. This underpins our expectation of rental growth for prime offices in 2024.

Accommodating Future Demand with New Supply

Unlike previous London office market cycles, the under-construction development pipeline falls short of meeting average levels of take-up of new and refurbished offices and, in fact, falls considerably below current levels of new and refurbished take-up. The potential pipeline of office schemes out to 2028 totals just under 17 million sq ft. However, we estimate that more than 65% of this pipeline is unlikely to be delivered within this timeline, due to a potent combination of declining developer confidence, planning challenges, or reduced scheme viability due to increased construction costs. And that is before one considers a tighter development finance environment that brings significant further downside risk to the pipeline.

The Race to Pre-let Space

Leasing trends for development schemes have seen significant change in recent years. Since 2016, a high proportion of schemes have achieved ‘fully let’ status ahead of practical completion (PC). Our analysis of development projects shows, on average, occupiers pre-leasing space up to 13 months ahead of PC. We expect the pre-let market will strengthen in 2024. And with demand outstripping supply, there will be pressure for rents to rise. This will be a welcome outcome to many developers currently hampered by high constructions costs affecting the viability of development projects. Against the backdrop of a large disparity between anticipated demand and availability, and the quality of supply, there will inevitably be less choice for occupiers, leading them to transact further ahead of lease events, increasing pre-letting activity and pushing up rental levels.

Figure 2 Take-up by Quality

Source: Knight Frank Research

The rental landscape for prime London offices is changing with rates of escalation not previously seen. Across both the City and the West End, where buildings have been delivered which present greater amenity, stronger environmental credentials and an enhanced workplace experience, occupiers have shown clear appetite to transact at new rental levels. This trend will continue in 2024 and given the sheer weight of rental evidence in the market over the last twelve months – together with our future expectations - necessitates a change in approach. Accordingly, Knight Frank are redefining London Prime Office rents going forward.

For further insight into these trends and the outlook for 2024 read our paper in full and to discover more about the resetting of prime office rents read Insight 2.1 on the following page.