Why tenants hold more power than they think when it comes to London office rents

Post-pandemic office rents and market activity were driven by the return – or not – to the office as businesses set their workplace strategies for the future.

The demand was driven by the pent-up demand for space, often fuelled by the need for new offices for those that might have chosen a hybrid route which meant that their existing space was no longer feasible.

It meant that the leasing market has remained buoyant. According to figures from JLL 2.6 million sq ft was let across Central London in Q2, taking the year-to-date volumes to 71 per cent above the same period in 2021.

Now the market is looking ahead at the potential impact of the current economic challenges, as well as the continued evolution of working practices to decide where to go next, and a surprising but consistent trend seems to be emerging. That is that today the tenant has greater power than ever over rent and what they want as part of their lease package before they sign.

The impact of market uncertainty on rent values

Because the evolution is continuing rather than over, and because economic turmoil is also impacting businesses, uncertainty over the future continues to reign. Many tenants are wanting to only sign-up for short-term deals because of this lack of clarity of future direction – with an increase in the demand for serviced and Cat A+ office space as a result. The option of plug and play options are easier – allowing greater agility and less of a need for upfront investment and so are increasingly attractive to potential tenants.

This has led to a polarisation of the market between low- and high-quality stock that is impacting the market and rents and which also vary by location. Extremes between Grade A rents and Grade B rents are more evident in traditional prime locations such as Knightsbridge or St James & Mayfair where the difference can be close to double. Other areas, such as Holborn & Bloomsbury and the City, have more comparable Grade A and Grade B rents. Meanwhile markets such as Battersea and Nine Elms or Hackney and London Fields, demand the lowest rents for both Grade A and B, costing at least half their City counterparts or a third of markets such as St James & Mayfair.

Yet despite the variety of availability and rent values the market is currently seeing an abundance of supply overall. According to research from CoStar, the trend for working from home has meant that there is currently 31 million sq ft – or more than one square mile – of vacant office space in London, the highest since it began recording. And yet rents have remained reasonably static, with prime London headline rents falling by only 1 per cent from their pre-Covid peak according to figures published by Carter Jonas in September.

Why that still gives tenants extra bargaining power

While this sounds like bad news for tenants the picture – for tenants at least – isn’t quite as bleak as it might first appear. Whilst headline rents may not have fallen what tenants are able to demand from landlords as part of their lease terms has increased in value.

Incentives such as rent-free periods are increasing in popularity and length, which in itself is also diluting the headline rent figures. In fact, once the impact of these rent-free periods is considered to produce a net effective rent then Carter Jonas’ figures suggest that the rents are showing as below pre-pandemic levels which means tenants are getting more for less.

The demand for quality

As well as incentives to sign, tenants are also wielding greater power over what they want from their space. Average offices will no longer do and where they are looking to invest in office space it’s a case of quality over quantity as companies downsize from lower-grade stock to smaller, but higher-quality, space. In the JLL Future of Work Survey 2022, more than three-quarters (77 per cent) of respondents said that investing in quality space was a greater priority than expanding space.

This means they are becoming more vocal in demands for what makes up their space too. Rather than using third-party contractors many tenants are demanding fully fitted-out offices from the start.

Understanding the impact of workspace evolution as well as the economic environment

The return to the office trend remains fluid, which means that many tenants remain fluid in their demands too – hence the trend for short-term space rather than long-term commitment. According to BNP Paribas Real estate average lease lengths for central London office space have halved in the last ten years to 6.4 years in 2022. This capability for flexibility is also appreciated by tenants and reflected in rents with a willingness to pay higher for reduced obligations.

That need for agility isn’t likely to disappear anytime soon since the future of work is still evolving. Even for those tenants whose employees may have committed to a hybrid working strategy the office environment still has a key role. It’s more than just a place for staff to work – instead it needs to support the workforce community more widely- so socially, as well as professionally.

Looking to future demands

As pressures continue, especially economic factors, landlords will need to continue to re-examine what they are offering if they want to fill space and reduce voids as tenants push harder for deals that suit them.

The continued polarisation between prime office space and lower quality office space is inevitable given the abundance of space available because the plug and play drive will mean that newly built or refurbished buildings will continue to be the preference.

This in turn will fuel landlord willingness to invest in providing CAT A+ and ‘plug and play space since they will have to do that to attract tenants – in turn giving potential tenants an even greater breadth of office space within the capital to choose from.

As ESG continues to rise up the corporate agenda tenants will also see landlords increasingly invest in such strategies since this will be another key differentiator in attracting organisations to take space, as well as being part of a wider active investment to allow the built environment to move towards a net zero goal by 2030. That investment by landlords will, in turn, will make it easier still for tenants wanting to ensure that they can also hit their sustainability and wellbeing targets within the office environment.

The future of the office is still not decided – but the options for tenants wanting to take space, offer greater versatility than ever. Quality office space in many cases will now be must-have rather than a nice-to-have and landlords will have to work hard to meet their tenants’ new demands.

Top tip

There is a shift to ‘fewer but better’ spaces that is contributing to the increase in demand for new and refurbished property across London.

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