Everything could change. Consumer sentiment is sagging under the weight of daily reports alleging that Brexit is making little progress. For now, though, investors in commercial property will retain a measure of caution, but are more likely to be influenced by the fact that demand for commercial property shows few signs of diminishing.
That’s a generalisation that needs qualifying because there are regional differences, or rather different perceptions for different reasons. The big regional areas such as Leeds, Birmingham and Manchester are benefiting from a lack of supply and solid growth after decades of stagnation, and it seems that sentiment towards London is less sanguine. However, the facts tend to suggest the fear is misplaced.
Leasing activity in London in 2017 reached 13.8m sq ft, up more than 2m sq ft from 2016, boosted by strong demand from technology and biotech companies. In fact, if you take away all the cranes involved on the residential side, and then deduct all the cranes working on pre-let commercial developments there isn’t much left. Furthermore, more than a quarter of these commercial developments will not be ready for occupation until 2020, suggesting there is likely to be a squeeze on availability until then. And yet the overriding feeling appears to be that rents in London have peaked and yield compression is a thing of the past.
An exodus from London shows no signs of happening, even though financial institutions have to plan well ahead of any potential relocation. Meanwhile, job creation is expected to outweigh any losses to overseas markets. Particular growth areas include small spaces, typically below 5,000 sq ft, which appeal to small start-ups and also a growing trend towards flexible office space. And as property consultant Knight Frank pointed out, supply peaked in 2017 and is now falling.
Overseas investors continue to provide a lion’s share of the funds heading towards the commercial property market and, as Capital Economics pointed out, net sellers in December of £146m were almost entirely Russian investors, while Far East investment, notably from Hong Kong, remained strong. It’s also worth remembering that as well as the investment return, whether that is through yield compression or rental growth, overseas investors also like the security that London offers, and there is little sign of this attraction diminishing.
Property developers have taken the sensible option, given the widely forecast demise of the London market, by scaling back on new developments. Indeed, property developers’ bank debt has halved since 2011 and shows no signs of picking up. This suggests that with pipelines remaining constrained, this will help to underpin existing rents. It remains less clear whether values will continue to grow; it would probably be fair to suggest that property values in London may well level out, with perhaps some slight widening in yields.
Meanwhile, the regions are enjoying and will continue to enjoy playing catch-up, with rental recovery currently far less advanced. And as Capital Economics points out, in the regions occupier demand is far less linked to the financial sector, with only 11 per cent of office jobs outside London related to the financial sector. Leasing activity remains strong in the nine principal regions outside the south-east, with take-up of office space up 10 per cent in 2017. Additionally, supply is still some way behind the increase in demand, with space under construction well below a year’s worth of take-up.
It doesn’t make any sense to speculate on how Brexit will affect financial services, trade agreements, freedom of movement and tariffs, if not for any other reason than that no one knows how these will all pan out. However, it is fair to say that London’s special place as a centre of commerce is unlikely to change. What makes up its ingredients, however, is already changing – and the property industry is well-placed to cope.
