Westminster Office Study - Impact of the Recession

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Westminster Office Study Impact of the Recession December 2009

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WESTMINSTER OFFICE STUDY - IMPACT OF THE RECESSION

Westminster Office Study - Impact of the Recession 1.

EXECUTIVE SUMMARY

1

2.

INTRODUCTION

4

The study area

3.

4.

5.

6.

7.

8.

OFFICE MARKET CONDITIONS

4

6

Office demand

6

West End availability

7

Development activity

8

Rental levels

9

IMPORTANCE OF THE FINANCIAL SECTOR TO WESTMINSTER

12

Westminster office occupier composition

12

Westminster office market occupier breakdown

13

Mayfair occupier composition

14

THE EFFECT OF THE DOWNTURN ON DEMAND

16

Take-up decline

16

Effect on financial take-up in Mayfair

16

EFFECT OF THE DOWNTURN ON SUPPORTING SERVICES IN MAYFAIR

20

Who are the supporting businesses?

20

The multiplier effect

20

Job losses

21

OUTLOOK FOR MAYFAIR OFFICES

25

Jobs forecast

25

Availability and development outlook

25

Issues to shape the recovery

27

CONCLUSIONS

30

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WESTMINSTER OFFICE STUDY - IMPACT OF THE RECESSION

1.

EXECUTIVE SUMMARY

1.1

The recession and subsequent downturn in economic conditions has hit the London office market hard. It is certainly not just Westminster that has been effected with take-up tumbling across Central London and beyond as the fall-out of the recession is felt across the UK.

1.2

Few occupiers have had the means or indeed the confidence to move despite rental levels falling significantly and landlords offering high rentfree incentives. Take-up for the West End to the end of September is down 64% from the same period at the peak of the market. Those few occupiers that have been able to take advantage of the market have had a choice of new buildings at significantly reduced rents.

1.3

Availability has risen 179% since the low point of the cycle, and the volume of available space in the market at present is approaching levels seen at the peak of the cycle in 2003. The West End is not alone in witnessing rising availability levels with the City of London also seeing availability levels rise by 152% over the same period.

1.4

Few new developments have started since the onset of the recession and the impact of this is now being seen in the completion levels. Despite a good volume of buildings with planning permission there is little actual development scheduled for completion in 2010, nothing at all in the current pipeline for 2011 and just one scheme under construction for delivery into 2012.

1.5

As a result, development activity across London will peak this year. The lack of future development will aid the reduction in availability levels as take-up absorbs the space currently on the market.

1.6

Rents in Mayfair have not been hit any harder in terms of percentage decline than any other area in the West End (falling 42% from the peak) and is similar to the 36% decline in the City. The falls recorded in Mayfair are similar to those last witnessed in the 90s recession.

1.7

Mayfair remains the most expensive location in the world.

1.8

Financial occupiers are an important component of both the Westminster and Mayfair office markets. In particular, the financial sector is a significant part of the Mayfair office market; both in terms of the volume of space occupied and the number of units.

1.9

The financial sector was a significant driver of take-up in 2006 and 2007. The credit crunch and the financial crisis and associated economic recession curtailed demand from this sector dramatically and financial take-up in Mayfair in 2008 was significantly below the peak level recorded in 2007.

1.10

However, despite the decline in floorspace being leased in Mayfair during 2009, the number of financial deals being agreed as a proportion of the total has moved little from the peak in demand during 2006 and 2007. Indeed, financial sector demand in Mayfair remains ahead of the longterm average as a proportion of total take-up.

1.11

The report poses the question “has Mayfair and in particular the financial sector been significantly effected by the downturn” and the results from the research shows that financial demand remains present in Mayfair and this occupier type remains an integral part of the demand profile of the

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submarket, albeit at a lower level in line with generally lower take-up levels - a trend seen across the London office submarkets. 1.12

There are a number of business types that provide supporting services to offices in Mayfair which are likely to be affected if office jobs are lost. Previous studies suggest a local relationship between office workers and supporting services of 1:29 i.e. for every 100 office jobs there are 29 local supporting jobs.

1.13

Westminster appears to have been protected from the worst of the impact implied by this theory and the borough is showing fewer job losses than expected. This is also highlighted through the interviews carried out on local businesses; 35% of occupiers interviewed had not witnessed a change in spending behaviour and the majority had not needed to reduce employee hours or make redundancies. We believe this can be explained by its unique location, office occupier mix and its global appeal as a tourist and retail location, as well as its residential population.

1.14

Looking ahead, confidence in the economy is returning, however forecasts are for consumer spending to remain low during 2010 and job losses to continue next year so it may be too early to see the full effect that this downturn has had on the local supporting businesses.

1.15

Office jobs growth in Westminster is expected to emerge in 2011. The recovery will be led by the business services sector while the public sector is expected to lag. The expectation of continued contraction in public sector jobs is unsurprising given the cuts widely predicted in this sector.

1.16

There is currently a relatively high supply of Grade A space in the West End. Over the next two years there is currently two years’ supply of Grade A space. (This is calculated by taking the total available supply and dividing this by the average annual take-up of new space). To put this into context, using the same measure the City currently has four years’ of Grade A supply and so is significantly more oversupplied.

1.17

Looking further ahead, future supply of new quality space in Mayfair remains low. This is due to developers lack of confidence, and the tight financial conditions resulting in the inability to build up the schemes they have planning permission for. As a consequence there has been minimal development starts over the last 18 months. This will create a period where new office space becomes scarce and occupiers will again be competing for the limited units available.

1.18

However, the timing of this recovery remains uncertain. There are a number of challenges that will shape the recovery in Mayfair. Not least that there is still the possibility that the UK could re-enter recession next year. Other factors could also weigh on the market such as tax changes and occupiers moving out of Mayfair to more cost-effective locations.

1.19

Westminster does, however, need a supply of new office space to remain a competitive world class business location. This research highlights how the reduction in values and market activity has affected the ability of developers to bring forward new schemes that comply with the multitude of planning policy requirements. The mix of complex policy requirements together with increasing levies on development (S106, Crossrail, CIL) may result in more schemes remaining in the pre-development stage, rather than progressing to full planning applications.

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1.20

The lack of finance available for development is another major issue. Developers with planning permission are now having to re-evaluate the schemes they have planning for as the decline in rents make many developments now financially unviable. This combined with a lack of lending to property developers will result in fewer buildings being developed in the short term.

1.21

This report identifies 700,000 sq ft of significant schemes with planning permission however there is little sign that developers are looking to start building. In the long term property is known to be very cyclical with rents and values fluctuating. It is expected therefore that viability will return in due course. However, in the short term it may still be prudent for Westminster to monitor the situation and to consider looking at ways to help developers schemes become more viable. This will ensure that there is a continued supply of world class office space for the occupiers who want to locate in Westminster, and particularly in Mayfair.

1.22

It is noted that Westminster Council provides a five year implementation period giving developers longer to develop the scheme, (compared to three years in the City of London). However this doesn’t encourage or help developers build in the short term.

1.23

The West End and Mayfair is still successfully attracting a mix of occupiers including financial companies. As highlighted in the previous study, the mixed-use environment and the Conservation Areas which are promoted by the planning policies of Westminster City Council are vital components of what makes the area popular, and, as found in this recent study, this policy appears to have helped the supporting businesses in the area survive through the recent recession.

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2.

INTRODUCTION

2.1

With the recent turmoil in the financial industry and the severity of the current economic recession, Westminster City Council have asked us to revisit our previous study and identify the impact the recession has had on Mayfair and St James’s – both the office market and the supporting services.

2.2

This report details how office market conditions have changed since 2007, the effect of the apparent increased reliance on the financial sector and the impact the recession has had on the office market. We have also investigated the relationship between office workers and supporting businesses to help understand how they have been impacted by the recession.

2.3

Additionally, we outline the potential outlook for the Mayfair and St James’s office market. The study area

2.4

The report refers to Mayfair and St James’s area as “Mayfair” defined by the map below.

2.5

Throughout the report when references are made to Westminster it is defined as the following area;

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2.6

References to “The previous study” refer to the report “The Importance of the Historic Environment to the Office Market in Westminster” which was a study carried out by Drivers Jonas for Westminster City Council in December 2007.

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3.

OFFICE MARKET CONDITIONS Office demand

3.1

The volume of transactions in the West End has been very low this year as occupiers retrench in the recessionary conditions. Take-up to the end of September 2009 has totalled just 1.1 million sq ft. This is a decrease of 38% from this time last year and 65% below the same point in the peak year of 2007.

3.2

Indeed, take-up for this year looks likely to be one of the lowest on record. We expect 2009 will finish below last year’s total of two million sq ft and be considerably lower than levels in the early 1990s when the West End last experienced an economic recession. This reflects the severe impact the current recession has had on the occupational market in the West End.

3.3

However, the downturn in take-up has been felt across the whole of Central London not just in Westminster. Occupiers have been reducing headcount and cutting costs and the acquisition of new office space has not been a priority in the poor business conditions.

West End and City take-up

9

m sq ft

8 7 6 5 4 3 2 1 0 90

91

92

93

94

95

96

97

98

99

00

West End

01

02

03

04

05

06

07

08 Q3 09

City

Source : Drivers Jonas Research

3.4

The City has experienced a similar downturn, however one deal (Nomura taking 540,000 sq ft of space (ie half of the West End’s total take-up this year) in the newly built Watermark House in September) has significantly boosted the City’s take-up figures for the year. Even with this deal takeup this year is likely to be low.

3.5

On a more positive note, in the West End the number of transactions being agreed has showed signs of improving during the third quarter; increasing from a low of 8 deals in April to 84 deals in September.

3.6

Sentiment has also improved since the end of the summer and demand is expected to increase during the final months of this year.

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West End availability 3.7

Availability of office space in the West End is currently at its highest level since early 2003 at 5.8 million sq ft, an availability ratio of 10% of the total stock. Availability has been rising due to the low levels of take-up combined with a rise in development completions.

West End availability 8

m sq ft

%

16

7

14

6

12

5

10

4

8

3

6

2

4

1

2

0

0 90

91

92

93

94

95

96

97

98

Availability

99

00

01

02

03

04

05

06

07

08

Q3 09

Availability Ratio (RHS)

Source : Drivers Jonas Research

3.8

Despite an improvement in take-up and increasing occupier confidence, availability is expected to continue to rise during the remainder of 2009. A number of developments are scheduled to complete during the final quarter of the year. These are likely to take availability up to the previous peak in the cycle (2003). However, availability is not currently expected to reach the levels seen in the early 1990s.

3.9

The volume of available office space has risen rapidly across all Central London submarkets. The City has experienced a dramatic increase in available space driven by low take-up and a large amount of new un-let development space completing. Availability has risen by 152% since the low point in September 2007, compared to the West End which has risen 179% in the same period.

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City availability 14

20

%

m sq ft

18 12 16 10

14 12

8

10 6

8 6

4

4 2 2 0

0 90

91

92

93

94

95

96

97

98

99

Availability

00

01

02

03

04

05

06

07

Availability Ratio

08

Q3 09

Source : Drivers Jonas Research

Development activity 3.10

Development activity is currently running at a cyclical high across Central London. 2009 will mark the peak of the cycle in the West End with 1.3 million sq ft completing.

3.11

At the end of September 2009 there was 1.8 m sq ft of space under construction, with nearly three quarters (72%) of this available to let. Just under one million sq ft is set to complete in 2010, with roughly half of that already let. However, development activity in the core areas of Westminster is very low with Central St Giles, St Giles High Street, WC2 accounting for 78% of the space available leaving limited options for occupiers looking for new quality space.

West End development pipeline

2.5

m sq ft

2.0

1.5 Average 10 yr Grade A take-up

1.0

0.5

0.0 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Completed

Available u/c

Let u/c

Source : Drivers Jonas Research

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3.12

Looking further ahead there are currently no buildings under construction for delivery in 2011. There is just one development currently scheduled to complete in 2012: the Crown Estate’s Quadrant scheme on Regent Street offering 200,000 sq ft of new office space.

3.13

The lack of new starts in the weak market conditions has meant that construction levels have fallen 28% over the last 12 months and 18% on six months ago. Development activity has fallen away quickly as developer confidence plummeted in the weak market conditions and significant hurdles such as availability of finance and viability issues are severely affecting future development. It looks likely that development activity will remain low for some time to come. Rental levels

3.14

The lack of occupier movement coupled with rising availability has had a significant impact on rental levels in Central London. Rents have fallen across all submarkets.

Prime London rents 140 £ per sq ft 120

100

80

60

40

20

0 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Q3 09 City West End Midtown

Source : Drivers Jonas Research

3.15

Prime rents in the West End have fallen 42% from the peak and are currently £70 per sq ft for a new Grade A building in core Mayfair. In comparison prime rents in the City have fallen 36% from the peak and are now £42.50 per sq ft. Midtown has experienced a fall of 32% from peak.

3.16

Incentives have jumped since the last report when rent-free periods were just six months on a ten year term in the West End and 12 months in the City. Current rent-free periods total 27 months on a ten year term in the West End and 34 months in the City.

3.17

As highlighted in the last study, prime rents reached record levels across all the West End submarkets in 2007. Since the market downturn all the submarkets have been hit hard and prime rents have fallen between 33% and 50%.

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3.18

Mayfair has been the hardest hit submarket across Central London in value terms with rents down £50 per sq ft from peak. However in percentage terms Mayfair has not been hit significantly harder than any of the other submarkets. Indeed, four out of the seven West End submarket areas have experienced bigger percentage declines.

Prime London rental decline from 2007 peak

0%

-10%

-20%

-30% -33%

-40%

-39% -42%

-43%

-43%

-45%

-50%

-50%

-60% Mayfair & St James's

NOHO

Soho

Victoria

Covent Garden

Paddington

Knightsbridge

Prime Rents

Source : Drivers Jonas Research

3.19

Net effective rents tell a similar story but show a slightly “truer” perspective of how far rental levels have fallen. Paddington, for example, appears to be holding up the best with just a 33% fall in headline rents. However when the rent-free period being offered is taken into account it is one of the worst hit areas with a 53% decline in net effective rents.

West End sub-market rental decline : prime v net effective 0%

-10%

-20%

-30% -33%

-40%

-39% -42%

-43%

-45%

-50%

-43% -48%

-51%

-52%

-50% -53%

-55%

-55%

-60%

-60%

-70% Mayfair & St James's

NOHO

Soho

Prime Rents

Victoria

Covent Garden

Paddington

Knightsbridge

Net effective rents

Source : Drivers Jonas Research

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3.20

How has the West End faired on a global scale? In 2007 West End rents were the most expensive in the world by some margin. Despite rents falling 42% over the course of the recession prime Mayfair retains its top spot in the TOP 20 GLOBAL OFFICE RENTS.

Top 20 global office rents

London (West End) Tokyo (Inner Central) Tokyo (Outer Central) Hong Kong Moscow Paris Mumbai Dubai London (City) New Delhi (CBD) Luxembourg City Rio de Janerio Milan Abu Dhabi Zurich Sao Paulo Dublin (Ireland) Geneva Istanbul Frankfurt am Main

us$/sq ft 0

20

40

60

80

100

120

140

160

180

200

Source : CBRE

3.21

The recession and subsequent downturn in economic conditions has hit the London office market hard. It is certainly not just the West End that has been affected with take-up tumbling across Central London and beyond as the effect of the recession is felt across the UK. Few occupiers have had the means or indeed the confidence to move despite rental levels falling significantly and landlords offering high rent-free incentives. Those few occupiers that have been able to take advantage of the market have had a choice of new buildings at significantly reduced rents.

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4.

IMPORTANCE OF THE FINANCIAL SECTOR TO WESTMINSTER

4.1

As reported in 2007, the financial sector was a key driver of office demand and the strong office rental growth recorded in Westminster at that time. Economic and financial conditions have changed dramatically since then and this has had a significant impact on the office market (as detailed in section 3). The next three sections investigate just how vulnerable Westminster and in particular Mayfair have been to these conditions. Westminster office occupier composition

4.2

Data from Experian Business Strategies (derived from the Office of National Statistics) shows that 71% of office employment in Westminster is from the Financial & Business Services Sector (FBS). Within this sector, the largest category is business services with 44% (eg legal and accounting, architects and engineering), followed by other mainly public sector jobs (18%) and financial (9%).

Westminster office employment by sector 2% 2% 1% 0% 2%

Business Services 4%

Other - Largely public 4% Banking & Insurance Property Related Activities

5%

Hotels & Catering 44% Retailing

9%

Public Administration & Defence Transport Education

9%

Health Wholesailing Communications

18%

Source : Experian

4.3

Please note - Public administration & defence is defined as Compulsory Social Security activities which includes employment in areas such as public security, law and order activities, fire and police service activities etc. Other – Largely public employment sector is defined by numerous employment sectors but is influenced by employment such as community, social and personal service as well as activities of trade unions, public political organisations, radio and television activities, cultural activities and civil servants etc.

4.4

Despite the significant number of financial deals during the peak in the last cycle, raising suggestions that the proportion of financial occupiers may have increased significantly in Westminster, the data shows that the

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breakdown of employment in Westminster has actually changed very little over the last 26 years. Westminster employment sector breakdown 100% 90% 80% 70% 60% 50% 40% 30% 20% 10%

08

07

20

20

05

04

06 20

20

03

20

20

01

02 20

00

20

99

20

19

98

97

Business Services Retailing Health Education

19

96

19

95

19

19

93

94 19

92

19

91

Banking & Insurance Property Related Activities Public Administration & Defence Wholesailing

19

90

19

89

19

88

19

87

19

19

85

86 19

84

19

19

19

83

0%

Other - Largely public Hotels & Catering Transport Communications

Source : Experian

Westminster office market occupier breakdown 4.5

Data from The London Office Database shows that, in terms of office occupation, the sector breakdown is different. This data can be split in two main ways: the total volume occupied and the number of units occupied. The public sector occupies the largest volume of office space in the West End with a quarter (25%) of the office space by volume in Westminster occupied by the central & local government sector. The financial sector occupies the second largest amount of space (18%) using this measure followed closely by the media sector.

4.6

However, if the data is analysed by the number of units being occupied by each sector it tells a different story. Financial occupiers account for the largest group with 18% of the market share by size occupied. So whilst the government sector occupies the most space the financial sector is an important component of the Westminster market both in the volume of sq ft it occupies and also the number of units occupied.

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Westminster occupier breakdown by number of units Financial Media

Financial, 18%

Property Professional Services Retailing Industry & Manufacturing Media, 15%

Associations Central & Local Government Construction Electronics Transport Leisure

Property, 13%

Services, 7%

Education Health

Professional, 10%

Utilities

Source : EGI

Mayfair occupier composition 4.7

Drilling down to Mayfair, where the majority of financial occupier activity has been seen over the last five years, the financial sector dominates both the volume of space occupied and the number of units. There is a mix of large financial occupiers in the area (such as UBS, York Capital Management, Gamesys Ltd and Triton Advisors) and a number of smaller “boutique” occupiers.

Mayfair occupier breakdown by sq ft Financial Property Financial, 27%

Professional Retailing Services Industry & Manufacturing Media Central & Local Government Associations Electrical

Services, 6% Retailing, 7%

Transport

Property, 14%

Construction Professional, 8% Leisure

Source : EGI

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Mayfair occupier breakdown by no. of units Financial Property Central & Local Government Professional

Financial, 29%

Industry & Manufacturing Retailing Associations Services

Industry & Manufacturing, 6%

Media Electrical Professional, 8%

Transport

Property, 14%

Leisure Construction

Central & Local Government, 9%

Source : EGI

4.8

Property is the second largest sector, which is unsurprising given the number of surveying and investment houses that have traditionally resided in the area. There has, however, been a noticeable outmovement by this sector in the recent past as noted in the 2007 report.

4.9

Although Victoria is seen as the main government location in the West End, the central & local government sector has the third most units in Mayfair: occupiers such as The Cabinet Office and the Canadian High Commission and a number of other embassies are present in the submarket. The American Embassy is a high profile occupier but this site will be redeveloped once they move out of the area to a new site in Battersea.

4.10

Unfortunately we are unable to show how the occupational volume or number of units has changed over time in Mayfair as the data is not available. However, a review of the financial occupiers in the submarket shows that the majority of the larger occupiers have been in their buildings for a number of years. Of the top 20 largest occupiers 70% have been located in the building for five years or more and 40% for more than 10 years.

4.11

Overall, it is clear that financial occupiers are an important component of both the Westminster and Mayfair office markets. In particular, the financial sector dominates in Mayfair, both in terms of the volume of space occupied and the number of units. It is key to note however that, at 27% of the volume of stock in Mayfair, the submarket remains behind the City (35% financial) in its dependence on this particular sector.

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5.

THE EFFECT DEMAND

OF

THE

DOWNTURN

ON

Take-up decline 5.1

All of the submarkets in Westminster have seen a decline in take-up over the course of this latest downturn. Mayfair take-up has fallen 64% from the peak, in line with the West End average. However, other submarkets have faired worse. The Soho market has seen a significant fall in takeup. This can be attributed, in part, to the area being heavily occupied by media companies who have been hit hard in this recession. Organisations are cutting marketing and corporate events and there has been little activity from this sector this year. Victoria and Paddington have been impacted due to the lack of government or/and large corporate demand.

Westminster take-up across the sub-markets: falls from peak 0% -10% -20% -30% -40% -50% -60% -70%

-57%

-59% -64%

-65%

-70%

-71%

Victoria

Paddington

-80% -80% -90% -100% West End

Knightsbridge

Mayfair/St James's

NOX

Soho

Source : Drivers Jonas Research

Effect on financial take-up in Mayfair 5.2

The financial sector was a significant driver of take-up in 2006 and 2007. The credit crunch, financial crisis and associated economic recession curtailed this dramatically and financial take-up in Mayfair in 2008 was significantly below the peak level recorded in 2007. 2009 is likely to be at a similar level to last year, if not worse.

5.3

Mayfair financial take-up in 2007 was almost five times higher than today’s level. However, that year it was running at 37% higher than the long-term average financial take-up of just under 300,000 sq ft per annum.

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Financial take-up 500,000

sq ft

450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 1985-2004 Average

2005

2006

2007

2008

Q3 2009

Source : Drivers Jonas Research

5.4

With financial take-up having fallen dramatically, it appears, on the face of it, that the drop in take-up in Westminster can be directly attributed to this steep fall in financial demand. However, this is not the case: in reality demand has fallen across all sectors. In fact, financial demand in Mayfair currently remains ahead of the long-term average as a percentage of total take-up.

5.5

At the peak of the market in 2006/2007 the sector accounted for 40-50% of the total amount transacted as measured by the amount of sq ft taken, ie roughly half the volume of all deals being transacted by size were from the financial sector. The last couple of years has seen the proportion of financial take-up reduce to a third as demand has fallen across London – back towards the long-term average for financial demand in the submarket.

Mayfair financial take-up by sq ft as a percentage of total Mayfair take-up by volume 70%

60% 53% 48%

50%

43% 40% 34%

36%

30% 30%

20%

10%

0% 1985-2004 Average

2005

2006

2007

2008

Q3 2009

Source : Drivers Jonas Research

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5.6

Indeed, despite the decline in amount of floorspace being transacted across Mayfair, the number of financial deals being agreed as a percentage of the total has moved little from the peak values.

Mayfair financial take-up by number of deals 60%

50%

47% 44%

42%

41%

40%

2008

Q3 2009

40%

30%

20%

10%

0% 2005

2006

2007

Source : Drivers Jonas Research

5.7

In 2006 47% of the number of deals agreed were for financial occupiers. This year so far (to the end of Q3) 40% of all the deals have been financial.

5.8

Looking forward, there are increasing signs that demand from financial occupiers is starting to pick up. Drivers Jonas’ monitor of active demand suggests that there is currently 400,000 sq ft of financial demand active at present across Westminster. In addition a number of financial deals transacted in Mayfair at significant headline rents (albeit also with significant rent-free periods).

Recent financial sector leasing transactions in Mayfair ADDRESS

OCCUPIER

SPACE TAKEN (sq ft)

PRIME RENT

TERMS

23 Savile Row

Resolution

10,000

£91.00

11 yr lease 12+3 months rent-free

23 Savile Row

General Atlantic

3,500

£85.00

10 yr lease 15 months rent-free

Devonshire House

Bain Capital

41,000

£90.00

15 yr lease 32 months rent-free

Source : Drivers Jonas Research

5.9

Mayfair is vulnerable to the current market conditions and has seen a reduced level of take-up both by the number of deals and the amount of space tenants are leasing. However, Mayfair has been hit no harder than the other submarkets of Westminster or indeed across Central London.

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5.10

Indeed, despite the recession the number of financial sector deals occurring in Mayfair as a proportion of total deals is stable. It appears from this data that Mayfair has not been adversely affected by the dramatic increase in financial demand seen in 2006 and 2007. Financial occupiers remain an important part of the demand profile of the submarket, albeit at a lower level – a trend seen across the London office submarkets.

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6. 6.1

EFFECT OF THE DOWNTURN SUPPORTING SERVICES IN MAYFAIR

ON

With take-up at record low levels and office jobs being lost as a consequence of the recession we were asked to investigate the relationship between office workers and supporting services and to look at how the supporting businesses of Mayfair office occupiers have fared. Who are the supporting businesses?

6.2

The businesses that support offices and office workers are identified below: Office suppliers (including stationery, toiletries, furniture etc)

Hairdressers *

Technology suppliers (including computer equipment, telephones, photocopiers etc)

Local supermarkets *

Maintenance / handyman

Coffee shops *

Office cleaners

Sandwich bars / cafés *

Local restaurants *

Delivery men / couriers

Local bars *

Taxis

Dry cleaners *

Local retail shops *

Cobblers *

Entertainment (night clubs, theatres) *

Gyms *

Newsagents *

* - likely to be based in our study area

6.3

The businesses asterisked in the table above are those that in our view are located in our study area. We noted a number of business types that provide supporting services to offices in Mayfair that are not located within the area: such as office cleaners, furniture suppliers and technology suppliers. These businesses are located outside of Westminster and, in most cases, are outside Central London. They will still be affected if office jobs are lost, but the impact will be felt beyond the Mayfair study area. The multiplier effect

6.4

We have found two studies that identify the effect the change in office jobs has on these supporting businesses. These studies refer to a “multiplier effect” which we can apply to Mayfair.

6.5

English Partnerships highlight a multiplier effect that is based on extensive evidence generated by a number of studies including the Evaluation of the Enterprise Zone experiment. They suggest the following:

6.6

PROJECT TYPE

LOCAL AREA

REGION

B1 Office

1.29

1.44

This theory suggests that there are two effects, the first being on the local area, and the second being the effect on the supporting services in a wider geography. The regional level has an overall multiplier effect of 1.44 meaning that for every 100 jobs 44 supporting jobs in the region are affected. The local area multiplier effect suggests for every 100 office jobs 29 supporting jobs are affected.

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6.7

The second study by P.W Daniels in 1983 “Service Industries : Supporting Role or Centre Stage?” supports the findings of the English Partnerships research by suggesting a multiplier effect of 1.30 ratio, ie 100 office jobs affects 30 supporting services jobs. We therefore feel comfortable in using the English Partnerships multiplier effect to help us understand the theoretical impact of changes in office workers on the local supporting services. Job losses

6.8

Experian record that Westminster lost 11,300 office jobs during 2008 and forecast the borough will lose a further 16,000 office jobs in total over 2009 and 2010.

Forecasted number of Westminster office job losses 30,000

job numbers

20,000

10,000

0

-10,000

-20,000

11

09

07

13 20

20

20

20

03

05 20

20

99

97

95

93

01 20

19

19

19

19

89

91 19

19

87

85

19

19

19

83

-30,000

Source : Experian

6.9

These office job losses will impact on those supporting businesses who rely on office worker spend. Using the multiplier discussed of 1.29, Experian’s 11,000 office job losses in 2008 would imply 3,200 supporting job losses. The actual figures from Experian show however that just 1,300 supporting jobs were lost in 2008.

6.10

The current Experian jobs forecast predicts a loss of 27,000 office jobs over the course of the downturn. The multiplier of 1.29 would suggest supporting business jobs in the area would be hit hard with a loss of 8,800 jobs over the three year period. It is possible however that the actual effect will be less than this. Indeed, the Experian forecast for supporting businesses losses is just 2,500 jobs – significantly less.

6.11

The theory is, therefore, suggesting a worse picture than the figures recorded in 2008 and the predicted effect over the next few years. Westminster appears to have been protected from the worst of the implied impact. We believe this can be explained by its unique location, its office occupier mix, and its global appeal as a tourist and retail location.

6.12

Indeed, retail vacancy rates remain relatively low in Westminster and particularly low in and around Mayfair. Data from PROMIS suggests that

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Bond Street vacancy rates are currently 2.6%, this has actually fallen from the end of 2008 when they stood at 3.3%. Retail vacancy rates 12

%

2009 Actual Vacancy Rates

Average Vacancy Rates

10

8

6

4

2

on

d of ity C

Ki

ng

s

Lo

R

nd

oa

re e

Ke n

si

ng

C

to

n

ov

H

en

ig

h

tG

St

ar de

tr e tS en eg R

t

n

et

t re e St or d O

xf

ht ig Kn

Bo

nd

sb

St

ri d

re e

t

ge

0

Source : Property Market Analysis LLP

6.13

Other key shopping areas around Mayfair have relatively low vacancy rates; mostly at or around the long-term average. Regent Street is showing a slightly higher than average vacancy rate - this can be attributed, in part, to the redevelopment/regeneration programme that is currently underway. It seems that the supporting retail businesses are, at the least, being cushioned by tourist footfall and robust retail sales volumes.

6.14

To further investigate the impact on supporting businesses in this area, and in particular to expand our analysis away from the main retail streets, we have conducted a questionnaire and interviewed a mix of 50 support service occupiers in the study area. The aim of these interviews was to get an “on the ground” feel of how local occupiers are coping with the recession.

6.15

Just under half of the respondents’ customers were office workers, almost a third being tourists and the remainder were thought to be residents.

6.16

The study found that most of the companies interviewed had seen their business affected by the recession. A significant proportion (70%) of those interviewed stated that overall customer levels have reduced.

6.17

Two thirds had seen customer spend decrease but a surprisingly resilient 35% of those interviewed had not actually witnessed a change in spend.

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Decrease

Stayed the same

Increase

Has customer spend changed?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Source : Drivers Jonas Research

6.18

Despite two thirds of those interviewed witnessing a decline in customer spend and customer footfall the majority have not had to reduce employee hours or make redundancies. Less than a quarter of those interviewed had to either cut staff numbers or hours.

Have you had to make redundancies?

Yes

No

0%

10%

20%

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30%

40%

50%

60%

70%

80%

90%

100%

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WESTMINSTER OFFICE STUDY - IMPACT OF THE RECESSION

Have you had to reduce employee hours?

Yes

No

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Source : Drivers Jonas Research

6.19

The overall results of the survey of the support businesses in Mayfair reenforces the Experian data showing that these services are not being hit as severely as the theory suggests. Mayfair seems to be fairly resilient to the current downturn and the mix of office occupiers, residents and tourist footfall appears to be helping the supporting businesses through the worst of the recession at the present time.

6.20

Looking ahead, the confidence in the office market is returning, however forecasts are for consumer spending to remain low during 2010 and job losses to continue so it may be too early to see the full effect that this downturn has on the local supporting businesses.

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7.

OUTLOOK FOR MAYFAIR OFFICES

7.1

As highlighted earlier in the report the market downturn has been led by the dramatic decline in demand for office space. This has driven availability up (as occupiers release unwanted space and new developments are not taken up) and rents down. The key to a recovery in rental levels in the market will depend on the outlook for the demand for office space. The best proxy for forecasting this is using the predictions for change in office sector jobs. Jobs forecast

7.2

The current forecast from Experian suggests that office job recovery in Westminster will emerge in 2011. The recovery will be led by the business services sector while the public sector is expected to lag. This expectation of continued contraction of public sector jobs is unsurprising given the cuts predicted in this sector. Indeed, there is a significant downside risk to the forecast that the losses will be bigger than currently expected.

7.3

Looking further ahead, the data suggests it will be a slow recovery and it will in fact take until 2017 before office employment numbers reach 2007 peak pre-recession levels.

Westminster office jobs forecast 10,000 Number of jobs

5,000

0 Health Education Public Administration & Defence Communications Transport Hotels & Catering Retailing Wholesailing Property Related Activities Business Services Other - Largely public Banking & Insurance

-5,000

-10,000

-15,000 2008

2009

2010

2011

2012

2013

2014

Source : Experian

Availability and development outlook 7.4

Rising jobs growth should drive increased demand for office space. However, this alone will not cause rents to rise; rental growth is dependent on the balance of supply and demand. History shows us there is a period of time when the demand absorbs the ‘excess’ space in the market before the competition amongst occupiers for available office space causes a rise in the price of the space.

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Mayfair availability split by grade 2.0

m sq ft

1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Grade A

Secondary

Source : Drivers Jonas Research

7.5

A review of the supply of office space on the market at present and the volume of space scheduled for delivery over the next two years suggests that there is two years’ supply of Grade A (ie new quality) in the West End market at present. This is calculated by taking the total available supply (present and scheduled for delivery) of 2.11 million sq ft and dividing this by the average annual take-up of new space (1.08 million sq ft). The take-up of new space is currently some way below average but, to put this in context, using the same measure the City currently has four years’ of Grade A supply and so is significantly more oversupplied.

7.6

Drilling down from this top level view and looking in detail at the units under construction shows that the majority of the new space being built is in larger units on the fringe of the West End markets (ie 375,000 sq ft at Central St Giles totalling and 200,000 sq ft at the Quadrant Scheme on Regent Street). The core Mayfair market has very little current development activity. This is because new development starts in Mayfair have fallen dramatically since the peak of the market.

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Mayfair new office development starts per year 300,000

sq ft

250,000

200,000

150,000

100,000

50,000

0 2006 Q1

2006 Q3

2007 Q1

2007 Q3

2008 Q1

2008 Q3

2009 Q1

2009 Q3

Source : Drivers Jonas Research

7.7

This lack of new quality supply suggests that prime rents could start rising rapidly in Mayfair as demand picks up. Indeed, historic data shows us that the Mayfair market has been the first of the West End submarkets to show rental growth in both the early 1990s and 2000s recoveries.

7.8

We are already recording a stabilisation in rent and rent-free periods being offered to tenants and expect rents for the best space will be rising again by the end of 2010. However, we believe that rents for secondary quality space, which currently makes up 81% of the total available supply in Mayfair, will take longer to recover in the low jobs growth environment forecast. Issues to shape the recovery

7.9

The economy: there are encouraging signs that the severe UK recession is ending. Despite this, economists believe there is significant capacity in the economy and forecast that employment growth in Westminster will not return until 2011. Continued unemployment and depressed wage increases means that recovery will be slow and fragile. There is also the warning from forecasters that the UK could re-enter recession next year after a weak recovery. This would have significant implications for the office market both in terms of jobs growth and occupier confidence.

7.10

Development activity: The active development pipeline is currently very limited, especially within Mayfair. This will allow the market to rebalance quicker than other parts of London – positive for landlords but raising rental costs and reducing choice for occupiers. In addition, the outlook for the next phase of development remains uncertain.

7.11

There is currently over 700,000 sq ft of significant schemes with planning permission in Mayfair including; • Park House - 190,000 sq ft • Cavendish Gate, Marcol House, 289-293 Regent St - 150,000 sq ft • 5-6 St James’s Square - 150,000 sq ft

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• 8 Grafton Street - 68,000 sq ft (part of the Grafton Estate new planning expected to include other buildings which will then total 200,000 sq ft as one development) • St James’s Gateway - 67,000 sq ft • 5 Hanover Square - 52,000 sq ft • American Embassy Site - 200,000 sq ft

7.12

More than half of these scheme were given planning permission over the last two years. The lack of finance is a major issue and will be a stumbling block to the majority of developers who have planning permission in place and who generally build without a letting. Additionally these schemes were put together with rents based on £100+ per sq ft. Rents have fallen to £70 and so the ability of developers to comply with their Section 106 agreement and planning tariffs attached to the planning permission given is also in question.

7.13

Due to a reduction in values and market activity, the ability of developers to bring forward new schemes that comply with the multitude of planning policy requirements may have also been affected. Planning policy requirements result in the need to create complex schemes, often with multiple cores to service multiple tenure types. Listed building and conservation area requirements, when applicable, also add an additional level of control.

7.14

Although a reduction in construction costs assists somewhat in balancing out expenditure relating to these complexities, the mix of policy requirements together with increasing levies on development (S106, Crossrail, CIL) may result in more schemes remaining in the predevelopment stage, rather than progressing to full planning applications. This is likely to exacerbate the limited development pipeline.

7.15

Although rents should rise due to the lack of space on the market, a gap between the current set of significant permissions and new schemes progressing to the application stage is likely to remain.

7.16

It may be prudent for the Council to monitor this. If necessary, a selectively flexible approach by the Council in the short term could increase the development pipeline while protecting long-term strategic planning needs, that appear to have shielded parts of Westminster from the full effects of the downturn. This approach could include lifting marginally the floorspace level that triggers a need to provide residential development, relaxing the need for refurbishments of office buildings to provide residential development, or progressing a ‘credit system’ for residential, as currently being considered in the draft Core Strategy.

7.17

It is noted that Westminster Council provides a five year implementation period giving developers longer to develop the scheme, (compared to three years in the City of London). However this doesn’t encourage or help developers build in the short term.

7.18

Tax increases: This may impact the Mayfair and wider Westminster office market in a number of ways. The 2010 business rates revaluation is expected to significantly increase the amount of business rates that occupiers have to pay and may deter some occupiers from taking space in certain buildings or even submarkets. The changes to empty property rates relief may impact developers’ strategy; at the least it will be an added factor in their development appraisals. The addition of a 50% income tax rate for UK tax payers has received a significant amount of

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press as a reason for high-earners and particularly hedge-fund managers leaving the UK for other lower-tax countries. 7.19

Occupational cost cutting: A recent trend, even before the recession, has been one of companies reducing overheads where possible. Mayfair has seen the exit of a number of high profile companies over the last few years including Rio Tinto to Paddington, DTZ to the City of London, and Schweppes from core Mayfair to outside London. With rents expected to rise in Mayfair from the end of 2010 it is likely that more tenants will choose to move as part of their cost cutting strategies.

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8.

CONCLUSIONS

8.1

The West End office market has changed significantly since we reported on the buoyant occupational market and record high rental levels at the end of 2007. The severity of the current economic recession has left the occupational market struggling. Take-up is at an all time low level as occupiers reduce headcount numbers and cut costs – the acquisition of new space has not been a priority. With little take-up and development levels peaking this year rents have fallen £50 per sq ft in value in Mayfair and availability is at its highest point for six years. However, this is by no means a West End phenomenon and the same story is being seen across the whole of Central London. For example, the City of London has seen availability rise by 61% since the low point in the cycle and rents have fallen 36% from the peak.

8.2

This study has investigated the effect that the downturn has had on the financial sector in Mayfair. This sector was previously a key driver of office space demand and rental growth. The results shows that while take-up has fallen dramatically, financial demand has not disappeared. Indeed, financial occupiers remain one of the dominant drivers of demand accounting for 40% of the number of deals that have occurred so far this year.

8.3

In reality, the data shows that demand has fallen across all sectors and financial demand in Mayfair currently remains ahead of the long-term average as a percentage of total take-up. Looking ahead, with economic conditions improving, financial sector demand is expected to remain an important component of the Mayfair office market.

8.4

Westminster prides itself on the mixed-use planning policy implementation and the resulting mix of residential units, retail, and office workers. This report records that Mayfair is showing a resilience to the market downturn with retail vacancy rates remaining low and fewer than expected supporting job losses. The retail market has not suffered as badly as expected; however the forecasts for consumer spending remain weak and job losses are expected to continue - the retail market and support services may not have yet escaped fully from this recession.

8.5

As highlighted in the previous study, demand for office space in Westminster is driven by the strength of London as a business location and tenants are attracted by the prestige and facilities found in the West End. Mayfair, in particular, has long been the location for the wealthy and has built up a reputation for being ‘the place to see and be seen’. Demand will return to the occupational markets in the West End and Mayfair once economic conditions improve, which forecasters suggest could be as soon as next year.

8.6

However, there are a number of challenges that will shape the recovery in Mayfair. Not least is the possibility that the UK could re-enter recession next year. Other factors could also weigh on the market such as tax changes and occupiers moving out of Mayfair to more costeffective locations.

8.7

A key factor is the very limited delivery of new office space. This report identifies over 700,000 sq ft of office space currently with planning permission however developers are not building. The development pipeline is extremely limited in Mayfair in particular: there is nothing

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currently due for completion post the second half of 2010. Growth and development will inevitably return to these areas as the property cycle continues its natural cycle, however in the short term development will remain at a low level. 8.8

It is evident that the mixed use policy requirements have resulted in successful and diverse locations within the Borough, which appear to have been better protected from the impacts of the recession than other locations dominated by one (commercial) main use. However, as reported in the previous study, the policy requirement to provide other uses in addition to offices on a single site may have reduced the potential level of new office space available, by adding a layer of complexity that may result in some schemes struggling for feasibility.

8.9

In addition, in the current market the feasibility of developments across all sectors is being exacerbated by the lower rents and the lack of development finance.

8.10

As mentioned above there are over 700,000 sq ft of significant schemes with planning permission, however there is little sign that developers are looking to start building. This is due to the lack of funding available from the banks, the financial viability of these schemes at today’s rental levels and developers uncertainty in the strength and timing of the recovery of the office market. It may be prudent for Westminster to monitor this situation in the short term to ensure that there is a continued supply of world class office space for the occupiers who want to locate in Westminster, and particularly in Mayfair.

8.11

Despite the downturn, the West End remains a vital part of London’s strength as a global city and is still attracting a mix of occupiers including financial companies. As highlighted in the previous study, the mixed-use environment and the Conservation Areas are vital components of what makes the area popular and appears to have helped the supporting businesses in the area survive. The lack of development activity along with an improving business environment should drive a return to rental growth for the best buildings over the course of next year, although there remain issues that will shape this recovery. This rental growth will help development viability issues and give confidence to developers; however Westminster should monitor this situation and ensure the Mayfair office market continues to thrive.

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DJ Research December 2009 This report provides forecasts based on statistical and general analysis of property market performance in the locations covered. It should not be relied upon as the sole basis for entering into transactions without seeking specific, qualified, professional advice. Whilst facts have been rigorously checked, Drivers Jonas LLP can take no responsibility for any losses, damages, costs and expenses incurred by any persons as a result of any inadvertent inaccuracy within this report.

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