How has this impacted the underlying occupancy market? While we believe that the impacts of this cultural shift are yet to be felt in full as longer-term leases expire, key data points show the flight to quality space is already in full swing.
The practice of hybrid work that has resulted from the pandemic has placed a larger emphasis on businesses choosing their office location based around new factors. Post 2020, providing a workplace to encourage staff to “earn the commute” with well-designed offices, amenity-rich facilities and surrounded by premium retail and leisure options, has become a key focal point. Avignon have identified the West End of London as a key proponent of this mentality, in comparison to other London sub-markets, and which is substantiated by both historic and current market statistical analysis.
The West End sub-market has seen the largest increased in employee occupancy levels over the past six months out of eight of the most major European cities, and now is very close to surpassing pre-pandemic levels. The average occupancy level in the City has improved too, albeit at a slower pace – this is driven by the more diverse occupier mix found in the West End compared to the City of London, South Bank and other sub-markets.
The demand is also reflected in the take up statistics. The average take up per quarter pre-covid (2018-2020) and post-covid (2021-2023) have remained almost identical at 725,000 sq ft. Furthermore, in contrast to market expectations, there have been no major trend of tenants decreasing their office footprint post-covid ; there has even been 12% increase in spaces taken over 20,000 sq ft.
Office vacancy rates are also substantially higher outside of the West End – Westminster currently registers a vacancy rate of just 4.1%, compared to the City core of 12% and Docklands of 17.5%.
Moving forward, we expect the trend of returning to the office to a more full-time basis to gain further momentum. It is anticipated that take up will continue to be strong for the best-in-class, future-proofed assets in the West End whist supply will remain tight as a result of higher construction costs and tight planning legislation.
Whilst an increased focus on sustainability has been accelerated by Covid-19, the green office movement is also underpinned by factors such as the climate crisis, employee wellness and talent attraction.
As the risk and cost associated with less sustainable assets becomes clearer, price discovery is likely to accelerate. Accordingly, the office market will likely see a growing divergence in asset value and performance between more and less sustainable buildings. Occupier demand will continue to distribute unevenly in a market experiencing a flight to quality toward high-quality, energy efficient assets.
Grade A offices require a variety of amenities such as green spaces, end of journey facilities (showers, changing rooms, bike storage), manned receptions, roof terraces, exceptional indoor air quality, efficient HVAC systems and dynamic layouts facilitating multi-purpose collaboration areas.
The persistent high inflation environment in combination with continuous interest rate hikes has smothered the investment market from the outset of the war in Ukraine. Transactional volumes are historically low. In H1 2023, European office investment was down 62% compared to the year prior and under 50% of the five-year average. Germany saw the biggest decline of 67% year-on-year with the UK close behind at decline of 61%. While this paints a bleak picture for those looking to dispose of assets, it presents an enormous opportunity to secure highly discounted assets within well-located sub-markets. In combination with a tailored and ESG focused value-add business plan, investors are presented with an opportunity to not only capture the continued increase in demand of high quality space within prime locations, but also benefit from yield compression as interest rate cuts are expected from H2 2024.
