Net effective rents for Grade A offices across central London are back to just 1% below pre-pandemic levels while headline rents have moved ahead, underscoring the strength of demand for prime and sustainable buildings.

Net effective rents are the net present value of all the rental payments over the period of a lease, as well as any abatements or incentives that might add to or lower these payments. They are therefore the key measure of rents in an office market.

Carter Jonas’ Central London Net Effective Rents Monitor reviews the impact of changes to headline rents and the typical length of rent-free periods across 22 key central London districts.

The index also analyses five and 10-year leases, as the length can have a significant impact on the net effective rent for each district.

Overall the central London office market saw an increase in the net effective rent of 4.2% during 2022, assuming a five-year lease. The equivalent figure based on a 10-year lease is 2.6%.

Carter Jonas points out changes in this property cycle has been much more pronounced for net effective rents in comparison with prime headline rents, and even sharper for a five-year as opposed to a 10-year lease assumption.

For the overall central London market, prime headline rents are now above their peak pre-pandemic level by 1.3%. Net effective rents are still below their pre-pandemic level, but by only 1% or both five and 10-year leases. The differential between five and 10-year leases that emerged during the pandemic has closed during 2022.

The overall central London figure masks wide geographical variations.

The West End has seen a stellar rise in net effective rents, which have increased by 12.7% since the pandemic low point in the second quarter of 2021, and are now 3.8% above their pre-pandemic peak. In Midtown, rents are now back to their pre-pandemic level, having increased by 8.5% since the second quarter 2021. In the City of London, net effective rents are still 1.5% below their pre-pandemic level, but have increased by 6.9% over the same period.

East London (including Docklands) is something of an outlier, Carter Jonas points out. Net effective rents have risen by only 4.1% since Q2 2021, and are still 6% below their pre-pandemic peak. The gap between Docklands and the other central London market areas has widened significantly.

The tightness of the West End submarket stood out. Rent-free periods offered by landlords have reduced by, typically, two months in all central West End districts, Carter Jonas reports. The districts with the tightest supply have also seen standout increases in prime headline rents over the last year.

Mayfair and St James’s have risen by 8.7%, and Fitzrovia has increased by 5.4%. The combined effect is an overall increase in the West End net effective headline rent of 7% in 2022 assuming a five-year lease, and 4.9% assuming a 10-year lease.

The City of London has also seen a rise in the net effective rent over the last 12 months, although at 4.3% assuming a five-year lease, and 3.2% assuming a 10-year lease.

Prime net effective rents in Midtown are 3.9% higher than a year ago assuming a five-year lease, driven by less generous rent-free incentives, which have reduced by one to two months, and a small increase in prime headline rents seen in Covent Garden.

East London (including Docklands and Stratford) saw little change in prime net effective rents during 2022, with an increase of just 1.8% assuming a five-year lease, reflecting a rise in prime headline rents in the final quarter.

Overall, prime headline rents across central London excluding the upper floors of tower buildings increased by 2.2% during Q4 2022, the first quarterly change since Q4 2021.

However, typical rent-free period incentives rose modestly in some districts. As a result, prime net effective rents increased at a slightly slower rate than headline rents in the final quarter. For five-year leases, the rise in net effective rents was 1.9%, while 10-year leases saw an increase of 2.1%.

Prime headline rents in the core City of London (Bank and Leadenhall Street) increased by 3.6% during Q4, primarily driven by the shortage of immediately available grade A stock, Carter Jonas suggests.

However, some fringe City of London districts record rental levels have been agreed on schemes that are setting new benchmarks for quality. For this reason, prime headline rents have increased by 5.8% in Shoreditch and Clerkenwell, and 11.5% in Spitalfields , reaching £72.50 per square feet in all of these districts.

The new developments driving this trend include Blossom Yard & Studios at Norton Folgate, Spitalfields, where law firm Reed Smith has signed for 126,800 square feet. In Farringdon, The JJ Mack Building has reportedly achieved rents of around £100 per square feet following the letting of 37,880 square feet to private equity firm Partners Group, setting a new record for the area, underpinned by the Elizabeth Line which has boosted its connectivity.

There has been a modest lengthening in typical rent-free periods in some City of London districts, as landlords focus on securing the highest headline rent at the expense of giving away a slightly longer rent-free period.

The overall impact of these movements has been a rise in the net effective rent for the City of London submarket of 2.3% assuming a five-year lease, and 2.9% assuming a 10-year lease.

In the core West End, prime headline rents have also increased significantly, with Mayfair and St James’s now achieving £125 per square feet, excluding the upper floors of super-prime buildings where rents of over £140 per square feet are more typical. This represents an 8.7% increase over the quarter, and reflects the acute shortage of available stock.

The Fitzrovia submarket saw its prime headline rent increase to £97.50 per square feet, reflecting a rise of 5.4%. Elsewhere in the West End prime rents were stable during Q4, and there was no significant change to typical rent-free period incentives in any West End submarkets. Carter Jonas reports that the overall increase in the net effective rent for the West End was 2.7% during the quarter.

In Midtown, prime headline rents were static apart from the Covent Garden district, which increased to £80 per square feet, a 3.2% uplift. The prime net effective rent increased by 0.8% in this submarket.

Docklands saw an increase in the prime headline rent from £52.50 to £55 per square feet, although the length of rent-free periods that landlords are prepared to concede has increased for 10-year leases, as they sought to attract occupiers and also underpin headline rents, Carter Jonas added. Overall, the prime net effective rent for East London (including Docklands and Stratford) increased by 1.8% during the quarter.

Carter Jonas says that against a background of inflation in excess of 10% and corporates under increasing pressure to reduce costs, plus with the autumn’s political and financial turmoil, it may seem surprising that net effective rents increased in Q4. But it says the terms of the deals against which these increases are benchmarked were agreed towards the end of the second quarter and during the third quarter, when the outlook was more stable. For the same reason, it expects the first quarter 2023 figures to show relatively little movement.

In fact, Carter Jonas thinks the first half of 2023 is likely to be a challenging one for corporate occupiers.

Cost pressures will increase not only through higher labour and input costs, but also due to the business rates revaluation, the rise in corporation tax, and debt servicing costs, it argues. It thinks many occupiers will be less willing to make major five or 10-year commitments to take new office space.

There is thought little speculative space due to complete this year, and as such high quality space will remain very scarce across much of central London, Carter Jonas says.

And that will help to support prime net effective rents, although this will vary according to district, with areas such as Mayfair and St James’s continuing to experience the most acute shortages of prime stock, while a greater choice will remain available to occupiers in locations such as Docklands.

Overall, the first half of 2023 should see static rent-free periods in submarkets where supply is scarce, Carter Jonas reports. In those areas where there is a better balance between supply and demand, including the City of London, Docklands and West London, weaker demand may mean that landlords offer slightly longer rent-free incentives to maintain headline rents at their end-2022 levels.

The analysis exclusively looks at grade A. Carter Jonas says the outlook for lower quality grade B stock is very different, as the shift in occupier preferences towards top quality space is being accelerated by the changes to energy standards regulations which are being phased in between this April and April 2030.

It writes: "As a result, landlords are finding it increasingly difficult to let space that is anything less than prime, and this is likely to result in further downward pressure on net effective rents for grade B stock in 2023, with declining headline rents and lengthening rent free incentives. In addition, we may see more secondary space coming back to the market as occupiers reduce their footprints, or potentially become insolvent, further exacerbating the imbalance between supply and demand in this market segment."