Central London Net Effective Rents Monitor Q1 2023

The Carter Jonas Net Effective Rents Index

Our Central London Net Effective Rents Monitor illustrates the combined impact of changes to both headline rents and the typical length of rent-free periods across 22 key central London districts. 

The Index also reflects different lease lengths by providing analysis of five and ten year leases, which can have a significant impact on the net effective rent for each district. 

Note: the impact of the timeframe for the ingoing tenant to carry out its fitting out works has not been factored into the Carter Jonas net effective rent analysis simply because the timeframe will be influenced by the quantum of space to be leased.

Trends in Q1 2023

Prime headline rents were static in most submarkets during Q1 2023, despite the ongoing lack of supply across much of central London. This doubtless reflects the uncertainty and rise in interest rates following last autumn’s ‘mini-Budget’, as the terms of the deals against which the Q1 rental levels are benchmarked would have been agreed during this period.

However, low vacancy still fostered prime headline rental growth for grade A space in a few districts in Q1, most notably in the core City of London (+3.4%) and Soho (+2.7%). These selected increases resulted in overall growth in prime central London headline rents of a modest 0.4% during the quarter (to read more about the latest office occupancy costs in London, click here).

There were also some modest reductions in typical incentives this quarter, with selected submarkets in the City and Midtown recording a fall of one month in typical rent free periods, notably for 10-year leases. As a result, prime net effective rents increased by just under 0.5% for a five-year lease, very slightly above the headline rate.

Source: Carter Jonas

Trends over the last 12 months

Looking at the change over the 12 months to Q1 2023, and prime headline rents across central London have increased by an average of 2.6%. Across the key submarkets, the strongest rental growth was seen in the City of London at 3.6%, closely followed by the West End at 3.4%. Docklands saw growth in prime headline rents of 1.85% over the year, whilst Midtown increased by only 0.8%. 

While some of the increases in rents can be attributed to the mismatch between supply and demand for sustainable grade A space across many parts of London, some are also explained by the development of new buildings that have set record rent benchmarks for their locations. 

In addition to this rental growth, typical rent free period incentives have reduced modestly in many (though not all) of our monitored districts. As a result, prime net effective rents for central London have increased at a slightly faster rate than headline rents over the last 12 months, at 3.4% assuming a five-year lease. If a 10-year lease is assumed, the increase is 2.7%.

In contrast to prime headline rents, the strongest increases in net effective rents have been in the West End, where rent free periods have fallen by typically one month over the last year. As a result, prime net effective rents in this submarket assuming a five-year lease have increased by 5.5%, with a rise of 4.4% assuming a 10-year lease, compared with the prime headline rate of 3.4%. This reflects the acute shortage of immediately available grade A stock with good sustainability credentials. 

Midtown has also seen a reduction in typical rent free periods of around one month over the last year across many of its districts, resulting in a greater increase in prime net effective rents than headline rents. Five-year net effective rents rose by 2.9% (and by 1.3% assuming 10 years), compared with the prime headline rental increase of only 0.8%.

In the City of London, prime net effective rents have risen broadly in line with headline rents at 3.6%, assuming a five-year lease, and a similar 3.5% assuming a 10-year lease, again driven by the shortage of immediately available “environmentally-friendly” grade A stock. In addition, some fringe City of London districts have seen rental levels agreed on schemes that are setting new benchmarks for quality and sustainability not previously seen in these locations, underpinned by the boost to connectivity provided by the Elizabeth Line. 

Docklands continues to see considerably longer typical rent free periods compared with the other central London sub-markets. A rent free inducement of 13-16 months is typical for a five-year lease in this sub-market, compared with 12-14 months in the core City of London, 9-12 months in Midtown and the South Bank, and 8-12 months across much of the West End. 

Typical rent free period incentives for a five-year lease in Docklands are largely unchanged from a year ago, but have risen for a 10-year lease by 1-2 months, as landlords seek to secure longer, and more certain, income streams from their real estate investments, and underpin headline rents, given the weaker demand and higher levels of vacancy than the more central sub-markets. Over the last 12 months, five-year net effective rents have increased at the same rate as headline rents (1.8%), although for a 10-year lease, the rise was a lower 0.8%, reflecting the increase in typical rent free inducements.

The change in headline and net effective rents by submarket over the last four quarters to Q1 2023 is illustrated in Figure 2.

Source: Carter Jonas

Rents compared with pre-pandemic levels

The continued recovery of both headline and net effective rents in central London is illustrated in Figure 3. The overall prime headline rent is now 1.7% above its pre-pandemic peak, and 2.8% higher than at the bottom of the market in 2021. 

However, the impact of the pandemic was mainly reflected in rent free incentives, with net effective rents falling by 8% peak to trough (assuming a five-year lease), compared with a fall of only 1% for prime headline rents. The market has now largely recovered and on this measure, prime net effective rents are now just 0.5% below their pre-pandemic peak, whilst headline rents are 1.7% above this level. 

Source: Carter Jonas

The overall central London figures mask the significant variation by sub-market. Figure 4 illustrates the movement in net effective rents over the last four years, assuming a five-year lease. This shows the very strong recovery in the West End, where net effective rents are now 4.4% above their pre-pandemic peak. Midtown five-year net effective rents have now recovered to be in line with their pre-pandemic peak level whilst in the City of London, growth in Q1 has taken the net effective rent to just 0.8% below its pre-pandemic peak. 

Net effective rents fell further in Docklands than elsewhere during the pandemic, and the recovery has been less rapid. With no change in Q1 this year, five-year net effective rents remain 6% below their pre-pandemic peak. 

Source: Carter Jonas

Outlook for Central London office space

Central London office occupier demand remains resilient for grade A space with good sustainability credentials, despite the downsizing currently being undertaken the tech sector and the recent problems in the global banking sector. These issues, plus the ongoing reductions that many firms are making to their real estate footprints, mean that we are likely to see weaker demand over the next few quarters. However, we should be close to the peak of the interest rate and inflation cycle, and business confidence appears to be improving. 

On the supply side, much of the space released back to the market by existing occupiers will be of insufficient quality for most firms seeking space. In addition, little speculative space is due for completion over the next few quarters. Therefore, we believe that the grade A market will remain intensely undersupplied relative to demand in many central London districts, most notably in the West End, Midtown and core City of London. This will accelerate the trend of occupiers currently located in the West End looking at the fringe City or Docklands markets, where availability is higher and rents are lower.

Given the combination of softer occupier demand but ongoing tight supply, we expect that prime rents and typical rent free incentives will remain broadly flat across much of central London over the next few quarters. 

There will, however, continue to be variations according to sub-market, and is some locations such as parts of the City and Docklands, where a greater choice of quality space is available to occupiers, we may see a modest increase in typical rent free incentives as landlords attempt to maintain headline rental levels.

It is important to note that these trends are only applicable to grade A space, which will continue to be the overwhelming focus for occupier demand. 

Detailed net effective rents by submarket

Figure 5 shows our assessment of current grade A net effective rents in Q1 2023 across all our central London submarkets areas (assuming a five-year lease).

Source: Carter Jonas
 
For further information on the Central London Office market, contact a member of our team.