Net effective rents in London's office markets have continued to rise for prime space in 2023 and are now just 0.5% below pre-pandemic levels, reports Carter Jonas.

Carter Jonas’s 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 central London districts. The index analyses five and 10-year leases, which can have a significant impact on the net effective rent for each district.

Prime headline rents were static in most submarkets during the first quarter of 2023, despite the ongoing lack of supply across much of central London. Carter Jonas says this reflects the uncertainty and rise in interest rates following last autumn’s mini-Budget, as the terms of the deals against which the Q1 rental levels are benchmarked would have been agreed during this period.

But low vacancy still led to prime headline rental growth for grade A space in a few districts, most notably in the core City of London (3.4%) and Soho (2.7%). These selected increases resulted in overall growth in prime central London headline rents of a modest 0.4% during the quarter.

There were also some small reductions in typical incentives, with selected submarkets in the City and Midtown recording a fall of one month in typical rent-free periods, notably for 10-year leases. As a result, prime net effective rents increased by just under 0.5% for a five-year lease, very slightly above the headline rate.

Over the 12 months to first quarter 2023, prime headline rents across central London increased by an average of 2.6%. Across the four key submarkets, the strongest rental growth was in the City of London at 3.6%, closely followed by the West End at 3.4%. Docklands saw growth in prime headline rents of 1.85% over the year, while Midtown increased by 0.8%.

CJ says while some of the increases in rents can be attributed to the mismatch between supply and demand for sustainable grade A space across many parts of London, some are also explained by the development of new buildings that have set record rent benchmarks for their locations.

In addition to this rental growth, typical rent-free period incentives have reduced modestly in many districts. As a result, prime net effective rents for central London have increased at a slightly faster rate than headline rents over the last 12 months, at 3.4% assuming a five-year lease. If a 10-year lease is assumed, the increase is 2.7%.

In contrast to prime headline rents, the strongest increases in net effective rents have been in the West End, where rent-free periods have fallen by typically one month over the last year. As a result, prime net effective rents in this submarket have increased by 5.5% on a five-year lease and a rise of 4.4% on a 10-year lease, compared with the prime headline rate of 3.4%. This reflects the acute shortage of immediately available grade A stock with good sustainability credentials, Carter Jonas says.

Midtown has also seen a reduction in typical rent-free periods of around one month over the last year across many of its districts, resulting in a greater increase in prime net effective rents than headline rents. Five-year net effective rents rose by 2.9% (and by 1.3% assuming 10 years), compared with the prime headline rental increase of only 0.8%.

In the City of London, prime net effective rents have risen broadly in line with headline rents at 3.6%, assuming a five-year lease, and a similar 3.5% assuming a 10-year lease, again driven by the shortage of immediately available “environmentally-friendly” grade A stock. In addition, some fringe City of London districts have seen rental levels agreed on schemes that are setting new benchmarks for quality and sustainability in these locations. CJ says this is being underpinned by the boost to connectivity provided by the Elizabeth line.

CJ says Docklands continues to have considerably longer typical rent-free periods compared with the other central London sub-markets. It says a rent-free inducement of 13-16 months is typical for a five-year lease in this sub-market, compared with 12-14 months in the core City of London, nine to 12 months in Midtown and the South Bank, and eight to 12 months across much of the West End.

Typical rent-free period incentives for a five-year lease in Docklands are largely unchanged from a year ago, but have risen for a 10-year lease by one to two months.

Over the last 12 months, five-year net effective rents have increased at the same rate as headline rents (1.8%), although for a 10-year lease, the rise was a lower 0.8%, reflecting the increase in typical rent free inducements, CJ reports.

Carter Jonas says the overall prime headline rent in Central London is now 1.7% above its pre-pandemic peak, and 2.8% higher than at the bottom of the market in 2021.

But the impact of the pandemic was mainly reflected in rent-free incentives, with net effective rents falling by 8% peak to trough (assuming a five-year lease), compared with a fall of only 1% for prime headline rents. The market has now largely recovered and on this measure, prime net effective rents are now just 0.5% below their pre-pandemic peak, while headline rents are 1.7% above this level.
 
The overall central London figures mask the significant variation by sub-market. Over the last four years, assuming a five-year lease, there has been a very strong recovery in the West End, where net effective rents are now 4.4% above their pre-pandemic peak. Midtown five-year net effective rents have recovered to be in line with their pre-pandemic peak level while in the City of London, growth in Q1 has taken the net effective rent to just 0.8% below their peak.

Net effective rents fell further in Docklands than elsewhere during the pandemic, and the recovery has been less rapid. With no change in the first-quarter this year, five-year net effective rents remain 6% below their pre-pandemic peak, Carter Jonas says.