Auteur

Cheng Bray

Senior professional support lawyer

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Auteur

Cheng Bray

Senior professional support lawyer

Read More

14 septembre 2021

Lending Focus - September 2021 – 1 de 6 Publications

The London property market after the plague

  • In-depth analysis

History suggests that we rarely abandon our capital cities. Rome has been continuously occupied for twenty-eight centuries. Paris has survived religious wars, famine and German occupation. Our own fair metropolis was hit by the Great Plague in 1665 which killed 100,000 people. The following year, fire destroyed the homes of seven out of eight Londoners. But within 18 months, London was rebuilt. 

It was great to meet Knight Frank's Liam Bailey the other day in sunny Marylebone to talk about what's currently happening in the London property market and to hear his views on the medium-term outlook. While Liam began his career as a rural estate manager in Suffolk, he became increasingly drawn to London and the urban residential market, joining Knight Frank in 2003. He is now Head of Global Research, his 115-strong international team providing worldwide market intelligence.

London is renowned for its architecture, innovative design and energy. Can you see its fortunes declining?

No, not in the long term. The pandemic has obviously been a huge shock to the system. The knee-jerk response to the first lockdown was to think that everything would change in the wake of COVID. There will be changes to behaviour and how people live and work – but initial assumptions will be found to be wide of the mark. Look at recent history and we can see similar examples. In the aftermath of the 9/11 attacks, many predicted the end of high-rise developments in city centres: who would want to inhabit such seemingly vulnerable buildings? In fact, precisely the reverse happened, with the following two decades seeing a boom in urbanism and tower-building across the US and globally. There is an inherent strength in cities and in the clustering of residents, workers, ideas and innovation – and London is a premier example of this.

What is happening now regarding London office lettings?

After an unsurprisingly uncertain 2020, we are seeing a recovery in the central London office market. We have seen a third successive quarter of strengthening take-up by occupiers, with signs that leasing transactions will continue to rise slowly during the remainder of 2021.

The most significant rise in active requirements come from 'new economy' growth sectors such as technology, media and telecoms companies, flexible office providers, health and life sciences companies. The improvement to occupier sentiment is demonstrated by a rise in rental growth in the core City and West End markets of London where rents have returned to pre-pandemic levels.

Overall, levels of availability have risen across central London, but remain below the peaks of previous cyclical downturns, while off-market tenant release space has been limited. The development pipeline to 2025 is likely to be constrained and fall short of typical levels of take-up for new and refurbished office space.   

How do you see office districts evolving?

There will be significant change to London's office markets, although this is not a new phenomenon. While post-war London saw zoning create large single-use office districts, already before the pandemic there were substantial shifts in many areas like the City, Canary Wharf and Midtown to incorporate a wider range of uses, with hotels, leisure, retail and residential all gaining ground.

Earlier this year, the Corporation of London published 'The Square Mile: Future City' which will support this process even further, although perhaps not as radically as some press coverage depicted. The plan is supportive of more mixed-use development – but the changes will be modest, with an ambition to find space for 1,500 housing units over the next nine years. The City Corporation explicitly recognises the need to protect the unique ecosystem that the City provides for businesses, whilst allowing for new uses. 

What is your thinking on offices, working from home and the demise of commuter culture?

The world has experienced the biggest workplace experiment in History. Many office workers have found that they can work effectively, some would say more effectively, from home than they can in the office. This has cheered many employers who spy opportunities for cost savings.  

There is no doubt that we will see an increase in home-working or variations of flexible working. But it seems equally likely that this will not represent a wholesale shift in behaviour.

The clearest lesson from the pandemic has been that it doesn't make a lot of sense to get workers to travel an hour to the office to process email and then travel back home for an hour in the evening. But at the same time, it has become painfully clear that recruiting new workers, training, creating teams, embedding workplace culture and sharing ideas becomes a lot harder – if not impossible – when done virtually.

The outcome will be likely to be a hybrid, with more people working from home one or two days a week. This change in behaviour may seem more modest than some anticipated – but it will have radical implications for some sectors. The economics of mass transit systems, like Transport for London and the mainline rail services in the UK, have a huge question mark over them. Retailers in office locations will be impacted, as will secondary office landlords.

Other sectors and locations will benefit. Regional or local centres around London have seen an increase in weekday footfall and retail spend, which could sustain an expanded restaurant and retail offer.

Turning now to retail and leisure activity in London, what are your views?

The challenges to retailers were already here well before the pandemic. The arrival of COVID merely accelerated the competition from online as well as adding costs through pandemic safety measures.

Rents and occupancy have been hit in most, but not all, markets in and around London. The same story of best-in-class locations (mainly central London) has seen some retail markets hold up well in terms of demand from shoppers and therefore certain retail occupiers.

Even far less well-located retail submarkets have benefitted from the easing of restrictions, which has prompted the release of consumer demand. Overall retail sales in Q1 2021 were up 21% year-on-year, with non-food stores up a massive 66%. Online's share of retail sales is receding to more normalised levels. Even online penetration has fallen back, after hitting a high-water mark of 36% during the pandemic. By June 2021, this figure had already fallen back to 26%.

Restaurants were of course hard-hit by successive lockdowns. The reopening in Q2 this year after lockdown restrictions were lifted has meant that London restaurant traffic was back to, and slightly ahead of pre-pandemic levels through July and August. One challenge for the central London industry is the replacement of international with domestic tourists, whose spending power is notably lower.

Industrial property isn't a sector one normally associates with central London…

No, but the relentless growth of storage and distribution is impacting even central London. The so-called 'last mile logistics' sector is a substantial growth area. The opportunities in dense urban areas are limited by the requirements of these buildings, with a need for excellent road access. Increased congestion charging in central London, the remodelling of roads to accommodate cycle lanes and the pedestrianising of areas clearly work against improved logistics. That said, there are suitable locations on the edge of central London, however, that tick the right boxes, and this will continue to be a growth sector.

I think it is a safe assumption that there will be continued demand for warehousing suited to servicing B2C distribution. E-commerce and online shopping platforms will continue to play a bigger role in the retail market than they did pre-pandemic. Online retailers and distribution firms continue to drive take-up as they expand the capacity of their networks in the long term. Robust levels of rental growth are anticipated, and forecasts have been revised up this quarter, as demand continues apace, while supply-side constraints limit the development of new stock.

Turning now to the residential sector, what are you seeing in central London?

London's residential market, like that in the UK, surprised substantially on the upside. House prices rose during the pandemic-induced recession - and that's an entirely novel trend. Prices rose by more than 7% in the year to the end of August. The support offered by the stamp duty holiday and the demand from house buyers looking for bigger or better space in the light of the pandemic were the big drivers. But it was this second issue which really propelled the prime London market.

While not as strong as regional UK markets, the central London market has experienced a notable revival in demand over the past year. Prices, which had been falling in prime markets over the past five years, turned positive in April this year as buyers bid up values of property across the most expensive areas of London.  

A record 198,240 transactions took place across the UK in June this year, 7.8% higher than the previous record set in March, according to provisional data from HMRC. This mirrored Knight Frank’s performance during the month, which also saw the highest number of transactions in prime London on record.  House price inflation is likely to cool in coming months as supply increases. We forecast that prime prices in London will rise by 2% in 2021 and 7% in 2022.

What about prime property prices in central London?

London is an international city and it's no surprise that international buyers make up around 50% of prime purchases - although half of those buyers are based in London. 

The main buyers have changed over time. A decade ago, for example, there were no mainland Chinese buyers. More recently, this group has become the biggest single foreign investor group in the London property market, although Russians are still the largest foreign buyer group in terms of value.

Historically, London has always attracted affluent overseas buyers who find London’s business cluster irreplaceable by any other alternative, and who also like the cultural activities on offer, and of course educational opportunities. In fact, education has been a significant driver of demand, contributing to upwards of £2 billion worth of prime property purchases each year across central London. 

Overseas investor appetite has clearly been impacted by COVID. Quarantine requirements, more complicated travel arrangements, the risk of unexpected lockdowns have weighed on demand. While some buyers, especially from South East Asia, have continued to buy off-plan, many buyers are waiting to visit London and inspect property before purchasing. During this period, European buyers have been more noticeable as well as domestic UK buyers. 

How do you think the ESG agenda will affect the property market?

I can’t think of many trends which have had such a big impact as rapidly as ESG. For developers, owners, funders, and occupiers of commercial property - this is an area that is unavoidable - although most focus is on E (for Environment) rather than the S (Social) or the G (Governance). 

The appetite for the best, most 'green' office or industrial space means demand for this stock is very high and rents reflect this. This is an area where the market is running in tandem with regulators. The more difficult area is the residential sector where government regulation is moving ahead of the market, in terms of consumer demand to pay for 'green' costs, but also ahead of the ability of the market to provide 'green' solutions at affordable prices for both new build and improving older homes. 

The question is, who will pay? Private homeowners will not want to foot the bill for modifications and as political parties need the support of these voters, they will inevitably tread carefully. Expect innovations such as 'green' mortgages (which offer homeowners loans on more favourable terms in return for buying 'greener' properties or more importantly for promising to improve the environmental performance of an existing building).

What are the big challenges facing the London property market?

I will be careful on this one - if you’d asked me the same question two years ago, I am not sure 'a new coronavirus' would have made my list. That said, there are a number of 'known knowns' which we can point to.

Demand for space will pick up as we move into the end of 2021, assuming there are no new variants which surprise us. But this rising demand will not be felt equally - the difference in performance between best locations and properties and second best has widened and will remain wide. Businesses will pay handsomely for accommodation if it meets their needs but if it doesn't, it will be disposed of as rapidly as possible.

While inflation still presents a threat to the market, especially for leveraged investors, the market is in a better position than in 2008, with lower leverage and in general better capitalised businesses in the sector.

Brexit appeared to become a secondary issue as soon as COVID came along. It shouldn't be ignored, however. London has so many positives, and in a European context has little real competition in terms of market size and dominance. It remains a financial and business services giant compared to other continental capitals. But the EU does not see this position as irreversible.

Unless the government and regulators in the UK can display the same urgency and sense of purpose as their European counterparts there are risks to this agglomeration of wealth and capital - with huge implications for the property sector. The City of London Corporation’s plan (mentioned above) was a good step, and there are others. It does feel though that the government could be more muscular in their planning for post-Brexit legal, financial and business regulation. 

London has built a unique ecosystem over a very long period, which has created a great place to do business and to work. It has so many positives to draw upon. Fundamentally, while COVID does herald change which may lead to a more mixed environment, there are huge opportunities for anyone involved in London's built environment.

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