The return of optimism

Office Property  
Mark Bourne, partner in Office Agency

The story of 2009 was of the great divide, the gap between the capital and the rest of the country. This will widen, with London experiencing a reversal of fortune, leading the office market recovery in 2010, led by the traditional financial sector. The worst is over for rents, though London will be the only market to see prime rental growth in 2010 (after 35 to 40 percent peak to trough fall). In the regions, the correction has been milder, so growth will take longer to return, though next year’s drop is expected to be less steep.

Vacancy has risen in most markets during 2009, but despite the high levels of availability, grade A space remains in short supply in some key locations. After the completion of existing developments, little new supply is planned bringing the potential for space shortages and pressure on rents during the recovery.

In London, the hot spot is likely to be in and around Canary Wharf. However, the London sub-market occupier appetite is set to drive vacancy back to single figures within the year. Developers will begin to look beyond the downturn, with speculative starts set for a return particularly in London where shortages of prime space will emerge by 2012. Central London may well see occupiers return to pre-letting to satisfy their future requirements.

Though London’s short-term future is bright, longer-term uncertainties remain. Political pressures to tax bank bonuses are currently intense and it is likely that other EU nations will follow (temporary) UK moves. Moves, to tighten bank regulation are also expected in the wake of the financial crisis. London’s position as Europe’s financial capital is not likely to be undermined, but these moves will have an impact.

Outside of London, prospects for demand have improved. Positives signs can be seen from the strong representation of regional markets in the biggest UK office deals of 2009. The largest involved the Co-op (325,000 sq ft) and Greater Manchester Police Authority (240,000 sq ft) both in Manchester, Birmingham City Council (196,000 sq ft), Nottingham City Council (213,619 sq ft – above) and Npower (220,000 sq ft) in Sunderland.

However there are risks to the outlook. Regional markets have relied heavily on local public sector deals to support take-up in the downturn and may be hit harder, as the government battles to cut its huge fiscal deficit post-election. Relocations from central government in London provide potential opportunities for larger regional centres, but plans are currently unclear and experience suggests that this will be a slow process.

Regional cities have seen a less aggressive fall in office rents in 2009. Nonetheless, prime rents dropped at an annual rate of 7 to 10 percent, with Birmingham worst hit. Regional rents are set to fall further in 2010, though the worst of the adjustment is now over and the rate of decline is expected to slow. On the basis of past demand and current supply, Manchester and Bristol are most likely to lead the regional recovery after 2010. The Scottish cities fared better than expected during the recession, but are likely to be slow to revive. Currently the biggest concerns are for Birmingham and Leeds, where over-supply and a reliance on the public sector make for the weakest prospects.

Industrial Property 
David Brooks, Head of UK Industrial and Logistics Group

Notwithstanding the slight improvement in activity seen in the last two quarters of 2009, occupational demand is likely to remain flat throughout 2010. Most activity continues to be at the smaller end of the scale, typically sub 20,000 sq ft.

This said, in the last two quarters of 2009 there was considerably more activity in the ‘big box’ market for warehouses over 100,000 sq ft. In contrast to previous years, when food retailers have been the major drivers of this market, waste management and recycling sector now offer a growing source of demand.

Lower pricing is attracting more occupiers back into the market – cash rich occupiers have started to return. Falling rents/capital values, but headline rents are generally holding up better than expected, due to longer rent free inducements being offered by landlords (which have largely doubled in the last 18 months). Yet tenant’s preference to conserve cash and look to landlords to incur substantial fit-out costs is resulting in longer leases being achieved in certain instances, particularly in the rapidly growing waste treatment/recycling sector.

Speculative development will not return until it becomes viable again and investor confidence returns. Build to Suits will be the way forward, for the foreseeable future. The lack of this development activity may lead to shortage of quality stock in certain locations – mainly in the South, but particularly the South East may also lead to some upward pressure on rents, towards the year end in those areas. A ‘flight to quality’ situation could well occur where most activity will be confined to new/modern stock in prime locations.
Rise in the number of demolitions of large industrial complexes following closure, due to growing obsolescence factor and to avoid empty rates liability. Landlords will have to continue to offer flexible terms to secure deals, with most activity has been confined to prime locations initially, where supply is generally tighter.

Retail Property
Charles Miller, Head of Retail

A year ago, with markets apparently in meltdown, no-one could have predicted how resilient retail markets would prove in 2009. Christmas 2009 has encapsulated the year as a whole – better than expected. However, this was obviously against weak comparatives. There are still ominous downside risks to the retail market. Interest rates will inevitably rise going forward, VAT will revert to its higher rate and the full effects of unemployment have yet to filter through to retail sales, even as the wider economy recovers. Rather than recover universally, retail sales will remain erratic throughout 2010 and beyond.

Though the key shake-out amongst occupiers occurred a year ago, weeding out the weaker players and those exposed to onerous finance structures, a number of further casualties are expected. Encouragingly though, vacated space is being reabsorbed back into the market. Overall vacancy rates may have risen as high as 20 percent during 2009, but are now starting to recede. Predictions are that they will fall to as low as 10 to 12 percent by the end of 2010, though this is an average with some areas faring significantly better than other.

Despite negative headlines surrounding the retail sector, space is still hard to come by in many markets, where occupier demand is not met through current provision. Retailers are constantly striving to optimize their respective portfolios, even if they are not expanding aggressively. There has been a discernible increase in out-of-town retailer demand, with more than 60 retail warehousing operators identified as on the expansion trail including the likes of John Lewis Home, Best Buy, Next Home and TK Maxx.
Despite signs of activity in both the in-town and out-of-town arenas, it will remain an occupiers’ market. As a result, rents will continue to decline for two more years to come, albeit at a slower rate than in 2009.

The rise of internet shopping continues, with online sales now accounting for around six percent of all retail sales. This figure is forecast to hit 10 percent by 2013, but the rate of growth is decelerating as the online market matures. As ever, it’s not merely a case of the internet versus the high street – many of the key winners in the market are multi-channel as opposed to pure-plays.
Supermarkets will continue to provide some salvation for the retail sector. Despite lower price inflation, they remain highly expansive, and will continue to absorb some of the over-supply in bulky goods retail warehousing and fallout from high street, as well as increasingly offering ‘anchor’ options for new developments. Food stores were also the only commercial property sub-segment to see positive rental growth throughout the recession.

In a very tight market, the supply pipeline has been derailed. Around 3m sq ft of new shopping centre space came on-stream in 2009. Although a significant proportion of this was let, it was on very favourable and incentivised terms to retailers. The pipeline will slow to a trickle over the next two years in the wake of financing issues and perceived occupier weakness. However, the next wave of development is already being lined up for 2012/2013, when market conditions are forecast to be far more conducive to new supply, as demand builds to a head.

To achieving a balanced pipeline, King Sturge endorse the recent submissions of the British Council of Shopping Centres to encourage rapid roll-out of a UK variation on Tax Incremental Financing and more generally, ensure that local authorities work with their development partners in constructive and progressive ways. In particular, more than ever, regeneration issues require innovative and proactive approaches.