Supply crunch in M25 market to drive office rents up

Reducing supply in the M25 office market is expected to lead to a 15% rise in headline rents over the next 12 months in prime centres, according to Knight Frank.

The M25 saw 57 transactions complete in Q1 2014, the most in a single quarter since Q2 2007, and take-up over the year to Q1 reached a six year high of 2.7m sq ft.

Supply levels in the M25 region are increasingly under pressure. Vacancy of New & Grade A space in the region has fallen to 5%, a ten year low.

In the M25 there are a growing number of key markets that have less than three years of office supply left, and this is expected to stimulate refurbishment and new development activity among developers.

On the back of improving occupier demand and anticipated rental growth, the M25 office market is now a hive of activity for investors, both domestic and, increasingly, overseas.

While demand remains as competitive as ever, transactional activity is being constrained by a lack of stock coming to the market.  Investment volumes in 2013 reached almost £3bn, the second highest year in record. Q1 just gone stands at £500m, a figure which would have been much higher had it not been constrained by lack of stock.

The strong weight of money in the market is putting upward pressure on prices. Prime yields now stand at 5.25%, 75 bps ahead of 2013 but still well short of the peak.

This is marginally ahead of the best regional city markets but nevertheless a significant 200 basis point discount to Central London.

While the funds dominate, the South East market is becoming an increasingly global playing field, with overseas investors accounted for over a quarter of the market over the past 12 months, including new entrants from Australasia and South America.

In addition to the improving occupier market, the Permitted Development Rights has stimulated developer appetite for conversion of offices to residential use. Research reveals that prior approval notices for conversion stand at 3.2m sq ft, equivalent in size to the Slough office market.

Emma Goodford, Head of National Offices, Knight Frank, said: “Rental levels in the M25 market have head room in prime towns with low supply. Areas that will achieve the best growth are the West London Boroughs, Reading, Uxbridge, Heathrow, with a rippling effect, moving to areas outwards of these, by Q1 2015.”

Tim Smither, Head of National Offices investment, Knight Frank, commented: “The imbalance between supply and demand is such that we expect prime yields to hit sub-5% by the year end. In the South East, for the first time in a very long time we expect rental growth in our core markets and this is generating heightened investor interest for secondary stock.”

David Jones, Partner, Residential Development Land, South East, Knight Frank commented; “Now is the time to explore the continued opportunity for change of use from Office to residential to meet the increasing demand for suitable residential development sites.”

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