The Bigger Picture
Estates Gazette

The Bigger Picture


The economic cycle has left some of the City’s most iconic new buildings empty. With space thin on the ground and the economy recovering, what do developers need to do differently to avoid the same fate next time around asks Jack Sidders

Standing at the edge of Bloomberg’s behemoth construction site in the City offers a rare ground-level panorama of some of the most striking office developments in London.

Statuesque above the hoardings as you look south-east from Queen Victoria Street is the Walbrook, the futuristic ground-scraper developed by the now defunct Minerva. Looming at its shoulder is Cannon Place, a similarly stately glass box developed by Hines. And soaring above them both, visible all the way from the South Bank, is the Shard.

Between them they offer more than 1.4m sq ft of grade-A office space and, at the time of writing, had yet to formally announce a single office tenant.

The Walbrook and Cannon Place, as well as a clutch of other City buildings not in view, were arguably the right product for the right market delivered at the wrong time.

They offer a cautionary tale about the dangers of speculative development in a highly specialised and cyclical market.

These buildings have suffered from the lack of requirements as the true effect of the financial crisis continues to pose fundamental questions about the future of banking.

Simultaneous to this ongoing structural change are signs of a wider recovery in the economy and the City property market. The insurance market in EC3 is booming and increasing interest from technology and media occupiers on the fringes has helped improve prospects for City development, leading commentators to forecast a return to speculative schemes later this year.

So, the question developers must answer is, what will be the right product for this prominent market in the next cycle Will occupier demand from banks return, or has the City undergone a structural change that demands a new way of thinking about development

Available space is shrinking
There is 6.9m sq ft of office space available in the City, according to Deloitte Real Estate – the lowest level for four years, and below the 10-year average of 7.8m sq ft.

Of that, grade-A availability ended the year at 2m sq ft, or 30% of available stock, almost unchanged from 2011. That was on the back of provisional take-up of 3.7m sq ft in 2012, well below the five-year average of 5.1m sq ft, according to Jones Lang LaSalle.

The low-take-up, low-vacancy environment has seen prime rents plateau at around £55 per sq ft for the past two years, albeit with a slight uptick to £57 per sq ft by the end of last year on the back of some sizeable Q4 deals.

In the wider economy, 2012 saw the double dip, followed by a radical and artificial bounce back in Q3, which is expected to go backwards in Q4 before beginning a slow, steady recovery from 2013.

The latest forecast from Oxford Economics suggests the labour market in London will grow with it, predicting a 1.2% growth in office jobs this year, triggering a revival that will see London top of the rankings for office employment globally for the next five years.

And that growth will come against a backdrop of increasing lease events. Knight Frank figures indicate 887,709 sq ft of City lease events in 2013 are set to more than double to 1.8m sq ft in 2014 and 3.3m sq ft in 2015.

Meanwhile, new commencements of speculative space coming to the market will be limited at best, with the whole of London delivering just 4.3m sq ft in 2013, 1.8m sq ft in 2014 and 188,000 sq ft in 2015.

Beyond this, there is nothing under construction speculatively across London, according to JLL. “As the current pipeline is inadequate to meet any upturn in demand, we expect speculative activity to begin again during 2013,” says Jones Lang LaSalle’s director of office agency, Chris Hiatt, in his predictions for the new year.

“As the next year progresses, recovering demand and falling supply mean that prime rents are set to show a more sustained revival – we are expecting growth of 4.4% in the City [to £59.50 per sq ft].”

Radical change
All this positive data masks a radical change in the occupier mix of the Square Mile that has taken place over the past couple of years, and begs the question of who new development should be geared towards.

The traditionally dominant banking and financial services sector, which accounts for a long-term average of 35% of City take-up, managed just 15% in 2012. This compares with 31% by technology and media and 24% by insurance, according to Colliers International.

The turnaround comes as the average deal size for banking – which accounts for more than three-quarters of wider finance sector employment in the City – fell to a record low of 9,864 sq ft, from 45,756 sq ft in 2009.

This paints a worrying picture for a sector that occupies 15m sq ft within the City core, or more than 25% of the total office stock.

Colliers’ head of City office, Mark McAlister, warns: “TMT occupiers need to step up a gear before they will make meaningful inroads into City take-up and fill the void left by banking demand.”

Looking ahead, the latest Centre for Economic and Business Research (CEBR) forecast suggests the picture is unlikely to improve.

CEBR estimates that the average number of City jobs is likely to fall to 237,000 in 2013 and 236,000 in 2014 – down from 354,000 in 2007, and the lowest level for 20 years.

The grim November forecast was reinforced this month by recruitment firm Astbury Marsden, which said the number of new jobs in the City slumped by more than one-third last year, with just 35,000 posts created, compared with 54,000 a year earlier.

Just 800 new jobs were available in the City in December, compared with almost 1,500 in the same month in 2011.

Several major banks are in the throes of large redundancy programmes, including UBS, which is axing 3,000 investment banking jobs in London as part of a wider 10,000-job cull.

Credit Suisse, Deutsche Bank and Nomurra have also announced cuts, while Barclays and Société Générale are expected to downsize their investment banking operations this year.

All this comes against a backdrop of tightening regulation and major global uncertainties, which have left many predicting the eventual recovery in banking will produce institutions of a very different shape to those we were accustomed to pre-crash, with major banks carving up their operations and investment banking likely to split from its retail cousin.

CEBR chief executive Douglas McWilliams says: “The fall in activity is partly a function of the weak economy, partly a hangover from the financial crisis and partly caused by increasing regulation, which limits access to bank cash to bankroll financial transactions. The business model for many firms in the City – which was based on taking a percentage from yields of 8% plus – has to change in a world where low yields are likely for many years to come.”

In the doldrums
So, with speculative development set to return while a traditionally dominant occupier sector looks likely to stay in the doldrums, what does this mean for anyone looking to build

Planning permissions exist for some major schemes in the Square Mile that might normally expect to cash in on demand.

Brookfield is sitting on the lion’s share of potential core City space with the mixed-use Principal Place – a 600,000 sq ft scheme with 45,000 sq ft floor plates; a majority stake in the 0.9m sq ft 100 Bishopsgate; and a 50% share in London Wall Place, another 500,000 sq ft.

That’s not to mention its contracting arm’s interest in the 945ft high Pinnacle tower, which is stalled on Bishopsgate.

But the stated position for each of these large schemes is that nothing will happen without major prelets, of which there are few, if any, in the market.

Almacantar chief executive Mike Hussey is a long-term bear on the City market who has called for a significant change of approach. “The thing with the City is that it has such an enormous amount of extant planning permissions, the question is, ‘are you building the right product” he says.

“I don’t think you can just keep building Walbrooks and hoping that someone will come in and fill them up.”

Hussey believes the vast number of permissions makes significant rental growth unlikely as the supply will always be available to meet demand, undermining returns for investors.

Despite the vast weight of overseas capital targeting London and the City, the long-term values of buildings in the Square Mile haven’t performed as well as might be expected (see IPD graph above). And prime rents, when inflation is factored in, have fallen.

Hussey argues for a change in policy from the Corporation, one that would respond to the needs of future occupiers and offer a better return for investors.

Financial services should be at the heart of the City, he suggests, but the buildings they will require will be different, with major banking requirements satisfied by the more efficient and cheaper space on offer at Canary Wharf. This will leave the Square Mile to cater for boutique financial occupiers and newer entrants by putting more of an onus on introducing more retail, leisure and residential.

“The City market has structurally changed, there is unlikely to be a lot of rental growth driven by expansion of big companies,”  he says.

“If you were given a choice as a propco to do a mixed-use scheme in the West End or a big speculative office development in the City, I suspect it’s a bit of a no-brainer at the moment – you would stick to the West End.”

The comparative attractiveness of development in the West End has not gone unnoticed by the major REITs, with British Land and Great Portland Estates refocusing their efforts on the other side of Kingsway, while other well respected developers such as Derwent have long eschewed it.

“This sector and the City is cyclical,” says Derwent chief executive John Burns. “And it is mainly for this reason that we have tended to focus our efforts on the City borders and on buildings that creative occupiers identify with more.”

In the past 10 years, the City has gradually begun to respond to the threat of Canary Wharf by bringing more life to the Square Mile outside of working hours, not least with the addition of a retail offering at Cheapside with One New Change.

Sir Stuart Lipton – who this week announced he is quitting Chelsfield to set up a new venture developing major London schemes – welcomes the move and believes the City must do more to “do its part in offering a more vibrant place to work”.

But he also believes developers must respond to new realities.

“Developers also need to change from offering all these weird and wonderful shapes to building simple, better and more efficient buildings that are practical to use,” he says.

A slow transformation
The transformation of the Square Mile into a place in which to eat, drink and shop has been slow, arguably helping other areas steal a march on the City.

Architect Sir Terry Farrell hasn’t worked in London’s financial district for almost 20 years, instead finding his talent for “place making” more in demand in areas like Vauxhall, Paddington, Earls Court and the South Bank.

Current major schemes include reinventing Wood Wharf in Docklands to bring in more residential, technology and media occupiers to the traditionally finance-oriented Canary Wharf.

“The rest of London wouldn’t have succeeded as much as it has if the City had been more open,” he claims.

“Our brief at Wood Wharf is to think about quality of life – the City of London has never thought about quality of life in that way.”

But his real bugbear has the makings of a classic development bust up and one he suggests is a microcosm of the wider problem in the Corporation’s approach.

Last year, Henderson Global Investors unveiled plans to redevelop the historic meat market at Smithfield, a two-acre site to which the City Corporation owns the freehold.

The site has a controversial history and the previous owners saw attempts to redevelop it stymied by then secretary of state Hazel Blears.

Acutely aware of this, Henderson has spent two-and-a-half years working up plans that preserve the Victorian façades and insert a five-storey office block of 95,000 sq ft above 43,000 sq ft of retail as part of a 230,000 sq ft scheme.

But despite the cautious treatment of buildings English Heritage has twice declined to list, the plans have provoked outrage from conservation groups, who have rushed out alternative proposals for a fashion and food market they say offer a comparable return.

Farrell acknowledges the days of the meat market are numbered and says his preference would be for a cultural centre, with Smithfield providing a new home for the Barbican and the Museum of London as part of a quarter to rival Spitalfields, the South Bank and Covent Garden “all rolled into one”.

But the point, he says, is that the City’s approach highlights an element of short-termism and a failure to see the wider picture.

“The City is hell bent on becoming a kind of grand urban business park,” he claims.

“But the days are gone when you can just think about office space as a commodity.”

If it is time to think about development differently, the City must now ask if it should start by rethinking Smithfield.

The time may be right for new development, but whether the current plans risk creating a new Walbrook on the other side of the Square Mile remain to be seen.