London has been in the press a lot recently. Coverage has typically been negative, predicting grave consequences on the office market due to Brexit. Look past the headlines at the evidence though and office occupational fundamentals remain robust.
In the two years since the referendum 139,000 new office jobs have been created in London, based on Oxford Economics figures, underpinning demand for floorspace. Take-up in 2017 was 13% ahead of the 10-year average, according to JLL. This trend is continuing with leasing activity in H1 2018 exceeding the long-term average by a similar margin. Furthermore, there have been some major corporate commitments to London over the last 2 years, most recently Facebook agreeing terms on 600,000 sq ft in Kings Cross for a net additional 6,000 staff. In our view, these aren’t the signs of stagnant market that has lost its competitiveness.
London’s office market has been accommodating structural employment change for some time. Knowledge-based professional, scientific and tech jobs have expanded rapidly at the expense of financial service sector employment and this is set to carry on (Figure 1). This suggests that London’s occupational market is less exposed to Brexit risk than many fear. In addition, we believe London has a number of strong thematic characteristics related to connectivity, networks and demographics that augur well for future long-term demand. Good quality office space remains constrained and the development pipeline is modest. Together these conditions should be supportive of rental growth.
Figure 1 – Selected historic and forecast employment change in London
Source: Macrobond, September 2018
However, the market is exposed to several short term risks. First, London is likely to experience adverse impacts from volatility in response to uncertainty over the outcome of any Brexit deal until more clarity on the direction of travel, so scarce up to this point, emerges. A trickle of jobs, physical and virtual asset relocations out of London has already occurred and this could well accelerate over the next few months. Second, investor demand for quality assets, particularly from overseas investors, has been maintaining pressure on yields which are at historical lows. Third, the market has seen rapid expansion of WeWork and other flexible office providers who compete for occupiers with landlords offering small suites (Figure 2). Take-up for this segment distorts the supply statistics whilst the business model has yet to be tested in a downturn. If it fails a significant volume of space could be returned to the market.
Figure 2 – London office take-up from flexible working providers
Source: JLL, September 2018
The expected short term volatility means that London offices are unlikely to suit funds that may need short term liquidity. However, funds with longer investment horizons could consider allocating equity to this market depending on their income requirements. Given our relatively positive long term view, London should be monitored closely as Brexit inspired volatility may present attractive buying opportunities.
Senior Analyst - Investment Strategy and Risk