Central London Net Effective Rents Monitor Q3 2022

The Carter Jonas Net Effective Rents Index

Our Central London Net Effective Rents Monitor illustrates the combined impact of changes to both headline rents and the typical length of rent free periods across 22 key central London districts. 

The Index also reflects different lease lengths by providing analysis of five and ten year leases, which can have a significant impact on the net effective rent for each district. 

Note: the impact of the timeframe for the ingoing tenant to carry out its fitting out works has not been factored into the Carter Jonas net effective rent analysis simply because the timeframe will be influenced by the quantum of space to be leased. 

Net effective rents – the headline results

Our index reveals the impact that changes to both headline rents and to rent free period incentives are exerting on grade A net effective office rents.

Prime headline rents (excluding the upper floors of tower buildings) were unchanged across all central London submarkets during Q3 2022. Over the last 12 months, prime rents have been virtually unchanged (with an average increase across central London of 0.2%, entirely due to rental increases in the Mayfair and St James’s submarkets).  

As Figures 1 and 2 illustrate, prime net effective rents have seen a considerably greater degree of change than simply looking at prime headline rents. The overall central London prime headline rent fell by only 1% from peak to trough following the start of the pandemic, but in contrast net effective rents fell by 6% assuming a 10-year lease, and by 8% assuming a 5-year lease. Since mid-2021, falling rent free incentives have meant a recovery of net effective rents, which are now only 3.0% below their pre-pandemic level (10-year lease) and 2.8% below (5-year lease). 

Q3 2022 has seen some movement in the level of typical rent free incentives, the net result of which has been a very modest overall increase in net effective rents of 0.1% (10-year lease) and 0.2% (5-year lease). However, looking at the different submarkets reveals some very different dynamics behind these overall figures. 

Much of the West End has an extremely low level of grade A supply across almost all floor sizes. The supply shortage is particularly acute in the Mayfair and St James’s submarkets, but is also apparent in submarkets including Marylebone, Fitzrovia, Soho, Bloomsbury, and Covent Garden.

This has resulted in a reduction in rent free incentives across much of the western part of central London over recent quarters, a trend which has continued in Q3. Assuming a 5-year lease, a tenant is typically able to negotiate a rent free period of between 8 and 12 months in the current market, compared with 12 to 16 months during the first half of 2021. The continued reduction in typical rent free periods has resulted in a fall in the prime net effective rent for the West End of 1% during Q3 2022 and a fall of 5.1% over the 12 months to Q3 (assuming a 5-year lease). This takes prime net effective rents for 5-year leases in the West End to 1% above their pre-pandemic peak. 

Midtown also has a shortage of quality supply. A modest fall in rent free incentives of 1-2 months has resulted in the prime net effective rent rising by 3% over the 12 months to Q3 2022, assuming a 5-year lease. However, there was no change during Q3 2022. 

The City of London has a greater supply of high quality space than locations further west, and has been broadly static in terms of headline rents over the last year, although typical rent free periods had been reducing and the headline rents on the upper floors of best in class tower buildings have been reaching record highs. However, we are seeing signs that this recent fall in incentives is now starting to reverse in the wake of less favourable economic conditions and greater caution by occupiers. Whilst the overall prime net effective rent for the City of London is now 2% higher than a year ago, there was little change – indeed it fell slightly by 0.1%, during Q3 2022 (assuming a 5-year lease). 

The Docklands market has seen only minimal change to rent free period incentives over the last year. However, we think there is increasing evidence of pressure on landlords to increase incentives, as there remains a large quantity of good quality space available set against weaker occupier demand. 

Recent trends in net effective rents, assuming a 5-year lease, are illustrated in Figures 3 and 4. 

 
Source: Carter Jonas

 
Source: Carter Jonas

Source: Carter Jonas

Outlook

Occupiers are once again in a period of heightened uncertainty, resulting from the current political turmoil, volatility in financial markets, reduced demand in the economy, higher salary and energy costs, and the rising cost of capital. This comes on top of the ongoing long-term shifts in working practices and the resultant downsizing that many businesses were already undertaking. 

We are likely to see a continued differential in rental performance between the main submarkets. There will be continued upward rental pressure in the West End, where grade A supply is extremely low. This pressure will reduce eastwards, with the market tipping more in favour of occupiers in the City of London, and with Docklands / East London seeing the lowest supply / demand pressures.

The choice of grade A space available to occupiers will only reduce further, given the low level of development. The rate of construction is unlikely to accelerate, given the current economic uncertainties and elevated building costs and the 2-3 year time lag from inception to completion. Whilst the current economic uncertainties will mean weaker demand over the next few quarters, low supply will quickly fuel further rental growth once demand starts to recover. 

It is important to note that our analysis considers only the performance of prime, grade A office space, which is now the focus of occupier demand. The recent performance of, and outlook for, secondary space is for continued falls in net effective rental levels, with a further widening of the differential between prime and secondary stock. 

Detailed rents by submarket

Figure 5 shows our assessment of current grade A net effective rents compared with a year ago across all of our central London submarkets area (assuming a five-year lease).

 
Source: Carter Jonas

For further information on the Central London Office market, contact a member of our team.