City of London runs short of offices

Copyright: David Lawson/Financial Times - Sept 2000

 There must be few people who would equate the City of London with Milton Keynes. But  the financial powerhouse of Europe shares one crucial similarity with the new town which suffers as the target of so many jokes. Whenever space runs dry enough for pound signs to dance before developers’ eyes,  an invisible hand reaches out and turns on the construction tap.

  ‘The City has changed from the days when you could rely on a perpetual shortage because of planning restrictions,’ says John Slade, managing director of Hamptons International.  This turnaround  was sparked when Canary Wharf emerged as a rival for big financial institutions and the City Corporation loosened its grip. Now the  threat of a potential flood of new space hangs constantly on the horizon. This is one reason why City  rents no longer set a market peak, nudging around £55 a sq ft  compared with more than £70 in the West End.

 Ironically, the square mile is currently so short of space that big names are fleeing to Docklands even faster than in the early years. Deutsche Bank is the latest reported to be decamping to Canary Wharf because it cannot find anywhere big enough to centralise in the square mile. But two or three years down the line sits a potential flood of new offices that could repeat the over-indulgence of the last boom, according to Andy King of  cityoffices.net, which provides online analysis of central London development.

 The market sits on a knife-edge, he says. ‘Lenders are not fuelling another boom – yet. But will this last in an overheated market and space shortages drive developers  to act like lemmings?’ A further irony is that the currently manageable overhang of 4m sq ft of space with planning consent could be tipped into crisis by more than 6m sq ft of  second-hand offices that deserters will leave behind. HSBC alone will offload around 1m sq ft from 2002, while more recent announced movers like Deutsche will continue the flood beyond 2003, says DTZ Debenham Tie Leung.

 Overlaying this is a burst of  mergers such as RBS’s takeover of NatWest, which will see further rationalisation of City space, says DTZ director John Forrester.  The picture is not as bleak as it may appear, however. Nick Baucher of CB Hillier Parker estimates that not all this  space will make it to the market, as  a third will be held by occupiers to meet further expansion.  Occupiers are notorious for underestimating growth. He also agrees with  Forrester that another large chunk will be taken back by landlords for renovation, delaying the impact for another couple of years.

  The surge of relocation to Canary Wharf will not last forever, however.  ‘It will be filled far earlier than we anticipated, which will cut off the escape route and even see occupiers bouncing back to the City from around 2005,’ says Mat Oakley, head of commercial research at FPDSavills.

   While this all lies on the horizon the City is coming to a fierce boil. Take-up reached 2m sq ft in the three months to June, according to the two biggest consultancies, Insignia Richard Ellis and Jones Lang LaSalle. This is the highest level since the pre-letting boom of late 1997, says Insignia, which forecasts current top rents of around £53 a sq ft will climb as high as £60 by the end of the year.

 JLL sees these values ‘cascading’ down through a market driven by  total demand of 1.5m sq ft - the highest ever recorded. This is dominated by requirements for buildings of more than 100,000 sq ft and another 90 new inquiries emerged in the second quarter – a dozen of them for more than 50,000 sq ft.  But smaller premises are also heavily represented, partly because demand from Internet-related businesses now outweighs traditional finance and banking firms.

 Insignia sees these pressures pushing occupiers towards the City fringes  -  a factor already picked up by Oakley, who notes that the dotcom sector formed more than a fifth of take-up in the first six months of this year and is concentrated in areas such as Islington, Clerkenwell and Brick Lane.

  Some of the biggest investors are taking advantage of rising returns to cut and run. Wates City is offloading its portfolio, as is MEPC, while the big German funds which bought into trophy buildings  so heavily a few years ago have the extra incentive of a strong pound to boost returns. JLL estimates around £1bn worth of stock is up for grabs.

 Debt-driven private investors have dominated turnover of more than £730m  (or £630m according to Insignia) in the second quarter. That means interest rate movements will be crucial for the investment market over the second half of the year. UK institutions have remained aloof, fearing a combination of obsolescence and over-supply eroding longer-term earnings.

 Andy King feels they have every right to worry about being in the wrong building at the wrong time. The Internet has been a boon by stimulating creation of dotcoms and soaking up space through an emerging generation of web-hosting centres. But ordinary occupiers are now  demanding connection to telecom services and will shun buildings unable to meet these demands.

  This sharpens the threat of potential new space, as it could drastically reduce the value of   older buildings. King suggests serviced office suppliers like Regus, MWB, Abbey and Nexus could benefit by harvesting these cast-offs.  The problem is that even this booming sector could be overwhelmed by so much space.