Our market
The UK economy officially left recession during the fourth quarter of 2009, supported by a combination of low interest rates, high government intervention and resilient consumer spending. Official figures from the Office for National Statistics, however, revealed that GDP growth in the fourth quarter was only 0.3%, indicating that the recovery is still fragile. This followed six quarters of economic decline and one of the deepest downturns on record. Overall, the UK economy contracted 5.0% in 2009 compared to growth of 0.5% in 2008 and 2.6% in 2007.
Now that economic recovery is tentatively under way, the health of London’s economy is crucial for driving the UK’s future growth. The capital city generates more than one fifth of the UK’s economic output, is Europe’s premier financial centre and is home to one of the most diverse, highly skilled and versatile labour pools in the world. London’s cosmopolitan culture and vibrant lifestyle add to the city’s long-term attractiveness to national and international occupiers.
This global city is our marketplace, in which we own and manage a diverse portfolio of innovative, intelligently designed yet affordable properties in a range of strategic central locations, with a particular focus on the West End.
Central London office occupier market
The central London office market comprises more than 20 million m2 (216 million sq ft). Within this, 49% of stock is located in the City, 42% in the West End and 9% in Docklands. In general, the West End – the geographical focus of our business – has the broadest tenant base. The area is home to a vibrant mix of media companies, professional and business services firms and specialist fund management houses. In contrast, the City and Docklands have a narrower focus on banking, insurance and legal services.
Recent office space statistics from leading surveyors CB Richard Ellis (CBRE) highlight the positive impact of the economic turnaround on our market. While take-up of central London office space hit a 20-year low of 258,000m2 during the first half of 2009, it rebounded to an above-average level of 581,000m2 during the second half of the year.
CBRE’s statistics also show trends in central London office vacancy rates that offer further reasons to be positive. Vacancies for the overall central London office market began 2009 at 5.3% and peaked at 7.7% in June, before falling to 7.2% by the end of the year. Looking at the second half of 2009 by sub-area, vacancy rates in the West End fell from 7.4% to 6.8%, while those in the City fell from 10.0% to 8.5%. This trend supports our strategy of delivering new office space to the market over the next few years. This strategy is reinforced by the fact that there has been little property development since the market slowdown and this is not expected to pick up in the near future with central London office completions estimated to total 382,000m2 in 2010 and 100,000m2 in 2011. Such levels are considerably lower than the long-term annual average of 504,000m2.
Improved operating conditions are starting to translate into signs of rental stabilisation. Again, with our mid-market, West End focus, Derwent London is particularly well placed to benefit from this trend. At the year end, prime rents stood at £860 per m2 (£80 per sq ft) in the West End and £475 per m2 (£44 per sq ft) in the City. This compares to our competitive mid-market rental focus of £325-£540 per m2 (£30-£50 per sq ft), which has proven more resilient to the effects of the downturn. We are now seeing a decrease in tenant incentives and believe that selective rental growth will return to our markets during 2010. The West End, where the supply-demand imbalance is most acute, and where the majority of our activities are focused, should experience the strongest market recovery. A new rating valuation takes effect from 1st April 2010 to be phased in over the next two to three years. This will increase tenants’ total occupation costs. However, it is anticipated that the effect at Derwent London properties will be lower than at buildings in higher rental areas.
Investor confidence returned during the second half of 2009
Central London office investment market
Investor confidence returned during the second half of 2009, with the lending market easing slightly, transaction levels improving, yields compressing and values rising. As a result, central London office investment transactions in the second half of 2009 totalled £4.7bn – substantially higher than the £2.3bn worth of transactions during the first half of the year and in line with the long-term average.
Early in 2009, the investment focus in London centred on properties secured on long-term income. However, with a limited supply of such assets, demand spread to a wider range of properties as the year progressed.
Attracted by the weakness of sterling, overseas buyers accounted for 73% of central London transactions in 2009 compared to the 10-year average of 49%. UK property companies comprised 11% of total activity, while domestic institutions accounted for 6%.
The IPD Monthly Property Index for West End/Midtown offices provides a clear illustration of the severity of capital value movements over the recent downturn. From peak to trough, over a 23-month period between August 2007 and July 2009, the index declined by approximately 45%. This adjustment was considerably quicker than that seen during the early 1990s recession, when the peak to trough period was 40 months and values declined by a similar amount.
The subsequent pick-up in values in the current cycle has been equally pronounced, with yield compression driving the above index up by more than 10% during the last five months of 2009.
