London Office Market Faces A Rental Recession

UNITED KINGDOM – Analysts at Jefferies warned that London’s office sector is facing a looming “rental recession” after the office occupancy rate in the capital fell to its lowest level in around 30 years, according to a report from the Investors’ Chronicle last week.

Following this warning, the stock prices of the four largest London office real estate investment trusts (REITs) have recently contracted. They are British Land, Land Securities, Derwent London, and Great Portland Estates.

Jefferies’ analysts Sarim Chaudhry and Mike Prew explained that the volume of vacant office spaces in London has hit a “tipping point” that will trigger a decline in office rents. In particular, the office vacancy in West End, the City, and Canary Wharf have reached 7 percent, 10 percent and 20 percent respectively.

The Jefferies analysts projected that the post-pandemic world of hybrid work will ultimately result in a 20 percent fall in demand for office properties in the UK capital over the long term, similar to the drop in shopping centre REITs from 2015.

Based on prior recessions, Jefferies thinks that an office vacancy level of about 8 percent, which all three London office submarkets have either surpassed or are close to exceeding, is sufficient to trigger a fall in headline office rent.

Coupled with the high inflation and the greater need for landlords to offer rental incentives to attract tenants, Jefferies think the four major London office REITs will struggle in increasing their net rental income over the coming years.

Furthermore, the Jefferies analysts are pessimistic over London office market’s dependence on coworking space operators, especially the loss-making WeWork, on absorbing office vacancy. The analysts estimate that flex space operators account for around 10 percent of the office leases in Central London.

The analysts noted that while coworking space operators had been absorbing office vacancies and supporting office rental demand, this demand is expected to begin declining. These flex space operators will face difficulties amidst a potential recession and are likely to slash their office footprint, leaving office landlords in the capital with even more vacant properties.