Leasing
As news of the COVID-19 pandemic worsened, activity in March tailed off significantly as occupiers adopted a ‘wait and see’ approach. As a result, Q1 2020 take-up levels are 45% down on the five-year quarterly average at 415,000 sq ft. This is 18% down on the same period last year.
Depending on the length of the pandemic, we expect demand levels to slow considerably over the next three to six months as occupier requirements are put on hold, in particular from smaller businesses. It should however be noted that the South East market is generally driven by lease events, which will still require occupiers to make property decisions.
Indeed, there are companies willing to continue with negotiations and go under offer since the lockdown; 705,000 sq ft is under offer currently, in 29 transactions, which is in line with Q4 2019. Identified demand stands at 3.5m sq ft, a 15% drop from the previous quarter. This is partly down to agent led enquiries not translating into identified demand due to a delay in inspections and the proposal stage, at which point generally, the client is identified.
The smaller size bands, <40,000 sq ft, continued to dominate take up and accounted for 90% of all take up in the quarter (by quantum). The largest deal of the quarter was Eli Lilly’s 42,000 sq ft letting at 8 Arlington West, Bracknell. Interestingly, the deal to the American pharmaceutical company was one of five within the Chemical & Pharmaceuticals sector in the first quarter, accounting for the majority share of take-up (37%). The usually prominent Financial and Business Services Sector accounted for just 16% of Q1 2020 take-up.
Other key transactions included Asahi’s 34,000 sq ft acquisition of Brook House, Woking paying a rent of £36.00/sq ft and PWC’s 30,000 sq ft letting at 40 Clarendon Road, Watford with a rent of £36.50/sq ft achieved. These deals represented record rental levels achieved in their respective towns, including Eli Lilly paying £29.00/ sq ft in Bracknell.
On the supply side, the vacancy rate stands at 7.3%, the lowest level since 2000. This coupled with an already constrained development pipeline, further put under pressure by a halt in construction, will further delay development completions. This will minimise any drastic falls in prime rents, especially as occupier bias remains for the best space. We do however, expect rent-free periods to move out over the next year.
The challenge over the short to medium term will be for landlords and tenants to work together. The biggest concern for tenants is meeting deadlines for fit out and transactions going forward. This will mean landlords taking a flexible approach to lease start and rent commencement dates. We are seeing transactions where landlords are prepared to offer tenants early access and/or a side letter covering off delayed rent commencement in line with delays to tenant fit out as a result of COVID-19. Some tenants are also protecting themselves by extending current leases albeit on a flexible/short term basis.
Investment
The year started with an almost tangible sense of optimism as confidence returned to the market following the Conservative’s substantial win at the general election in December, which contributed to total investment activity in Q1 2020 of £1.064bn. This is 23% up on Q4 19 and 163% up on the same time last year.
There were three notable transactions, which alone totalled over £570m; Cisco HQ, Bedfont (sold by BNP Paribas), Building 7, Chiswick Park and Arlington Business Park, Theale all of which were acquired by Asian investors. This trend felt like it would only continue to gain momentum as Asian investors had been missing from the market during the Brexit years. However, two weeks from the end of the quarter activity slowed with the start of the COVID-19 pandemic.
Encouragingly, however, transactions have continued with two of note being 300 Capability Green, Luton and Honeywell House, Bracknell exchanging and completing in late March and totalling nearly £100m. An overseas investor and a UK local authority respectively purchased these.
Looking ahead, we expect to see a widening divide between those investors who can and will continue to acquire assets namely U.K. and Overseas private investors and U.K. local authorities and those who will pause namely U.K. institutions and listed property investors. The list excludes private equity who we expect to continue to be active however, their pricing will be governed by the cost of debt which is rising.
The current situation raises more questions than answers at present however, we believe weaker sterling has made the U.K. more attractive to overseas investors and investors will continue to be attracted to the relative income yield of real estate. Anecdotally, office led landlords received 70-80% of their rent by the March quarter day compared to 25-30% for retail led landlords. Going forward, greater emphasis will be placed on covenant strength.
As we write the debt market has undoubtedly become thinner and more expensive. However, the gilt market will stabilise following which lenders will be able to price debt with greater confidence, at which point we expect debt to be very attractive on a long-term basis.
