5 Occupier Trends Shaping London Office Leasing

With more than 20 years of experience analysing commercial real estate trends, Lee Elliott joked that he’s probably on his fourth iteration of the “death of the office” narrative, with this era’s brought about by the COVID-19 pandemic. The Knight Frank partner and head of the firm’s global occupier research said that “we still have offices and will continue to have them, though they will begin to change in their form and function”.

“People always talk about when we’re going to get back to 100% occupancy of office buildings. Well, we’ve never been at 100%. Pre-pandemic, we were at 60% to 70% in London, and now it’s at about 40% to 45% [as of Q2 2022],” Elliott continued. “This is just the normal volatility that one puts up with in the market. We’ve got a way to go, but thankfully we’re seeing that ‘death of the office’ narrative go away.”

That doesn’t mean that London’s office market hasn’t seen changes due to the pandemic. As occupiers become more educated, strategic and deliberate about their next office location and interior buildout, specific demands are taking top priority in leasing decisions – and buildings and landlords that offer them are winning out.

Below, LoopNet investigated the occupier needs that are driving office leasing activity in London, characterised by a notable flight-to-quality movement; the desire for highly-amenitised buildings; locations in prominent and accessible areas; sustainable features and accreditations; and flexibility.

Against the backdrop of political administration changes and looming economic concerns, occupiers are being more cautious about their leasing decisions. It doesn’t mean they aren’t taking up office space, but that they are being more precise and intentional about what they’re looking for and how their next office will fit their future needs, said Elliott.

"What’s happening is the demand is becoming much more qualified. It's much more clear what people want and why they want it,” he explained. “If I was to summarise what I think that means for the London market, it's a market that's much less characterised by quantity and much more characterised by quality.”

The flight-to-quality movement is perhaps one of the most prominent trends shaping leasing activity in London. As companies embrace the changing nature of work and evaluate what purpose the physical office serves, they may take less space, albeit higher quality space, that’s more conducive to the in-person collaboration companies are using the office for today.

Tenants are now looking to get the most bang for their buck, so to speak, leasing the best space possible within their budget. As a result, they’re looking for five-star properties in desirable locations that are close to transport, rife with amenities and environmentally sustainable.

London’s office vacancy rate – across all building types – rose during the pandemic to a current 15-year high of 8% according to data from CoStar (the publisher of LoopNet), compared to a pre-pandemic low of about 5%. But while the vacancy rate for four-and-five-star properties is high at 9.5%, these properties are also the only ones with positive take-up compared to properties with three or fewer stars. “What’s been driving that uplift on vacancy is people giving up poor quality stock,” Elliott said.

Demand in London's five-star office buildings has remained positive throughout the past two-and-a-half years, while older, poorer-quality stock registered more than 10 million square feet of negative net absorption during this time, according to CoStar.

The desire for high-end offices is also accelerating another phenomenon in the London office market – unprecedented preletting activity.

London has about 15 million square feet of office space under construction and set to be delivered by 2025 according to data from Knight Frank, which Elliott said isn’t a lot compared to historic norms. Deliveries in London have been tracking at about 1 to 2 million square feet per quarter over the past several years, according to CoStar.

While the construction pipeline is high, landlords are less likely to build without a prelet in place in the face of inflation, labour challenges and higher financing costs. With tightening supply, tenants are making commitments to buildings that have not yet broken ground to lock in the quality they want.

“They're doing that earlier, some even while they have an existing lease contract in play, sometimes six years before their lease break, believe it or not,” Elliott said. “We're also seeing it happen for smaller amounts of space. The rule broadly used to be that you needed to lease 250,000 square feet or more to make a pre-commitment. We're now seeing it closer to 100,000 square feet.”

According to CoStar, about 60% of office space currently under construction in London is prelet.

Christopher Dunn, head of insights for London offices at Colliers, emphasised that flight-to-quality isn’t a new phenomenon for London’s office market.

“Occupiers will always get the best space they can afford. Because we're seeing some occupiers take less net space than they would have before, they are then able to potentially afford better quality space for the same rent roll,” he explained. “We are particularly seeing that in the West End, that push for the best – not necessarily the best overall – that they can afford within their budget. But I think that’s something that would have been the same pre-COVID.”

Alongside the flight-to-quality movement, Elliott said the office market is also experiencing a “flight-to-amenity” dynamic. As employees return to in-person work after the pandemic, “the workplace has to be more than just the building”, now more than ever. “If you want people to be in the office, you need to make it quite a compelling proposition. Don't forget that the London labour market, on average, has over an hour commute, and it’s becoming ever more expensive. So, you need to give people a reason to be there.”

Occupiers are most focused on amenities that benefit physical health and overall wellbeing, such as fitness centers and yoga rooms, and quiet spaces that allow for mental breaks or recharging, Elliott said. The pandemic also accelerated the already increasing demand for outdoor space and open-air areas, especially in large tower-heavy areas in Central London.

Elliott foresees the next frontier of the wellness amenity category focusing on employee growth and development, which could take the form of libraries or educational spaces that enable employees to take advantage of informal or flexible learning initiatives.

“This is a business imperative for the employer as well as the employee. Even if we do have slightly choppy waters from an economic standpoint, we've still got pretty tight labour market conditions,” he said. “So actually, it's contingent upon employers to start upskilling and reskilling the staff they already have, rather than just relying on bringing them in.”

The one very specific ask the Colliers occupancy agents have been getting from almost every occupier client is for cycling storage and facilities, said Dunn. It’s an amenity that’s becoming even more important as people prioritise environmental consciousness.

And new office buildings that can build cycling facilities into the project from the beginning gain a competitive edge. “Older buildings in particular in London don't have the lower ground space to unlock lots of spaces for bicycles and showers,” Dunn said. “So some of those buildings are less desirable now than those that are refurbished or newly built, where commuters can cycle straight from the street into what effectively is a cycling cafe.”

Beyond the physical amenities of a particular building, Elliott emphasised the importance of what he said are “service amenities”, or offerings that focus on customer service and programming for tenants.

Owners should look to incorporate technology into the building’s infrastructure that can provide occupiers with convenience, such as building access, meeting room booking or tools for hybrid work setups. They should also incorporate technology that arms occupants with real-time data to make better decisions for their business, such as employee tracking for optimal space usage or energy monitoring to control utilities.

“Occupiers are increasing their willingness to spend more on service charges to create a better experience and environment for their staff, even though it increases their total occupancy cost. And they are looking at landlords more and more to partner with them to offer that,” Elliott said. “The real estate industry often thinks that everything begins and ends with rent. But for occupiers, rent is only about 12% of their operating costs. More than 60% of the cost is people. So, if you create a poor working experience or environment, you end up seeing much more attrition in your staff and that's much more costly.”

Office building location essentially didn’t matter for the almost two-year period of COVID-related lockdowns and remote work. As people geared up to return to in-person work, many thought preferences would shift to favour suburban locations closer to where employees lived to reduce commutes to downtown.

“Twelve to 18 months ago, everyone was saying there would be radical changes. But I think as time has gone on, [real estate] has just gone back to the fundamentals,” Dunn said. And one of the age-old fundamentals of successful, in-demand real estate is none other than location, location, location.

Some areas of London, such as Paddington and Farringdon, which were previously less desirable due to their inaccessibility for most commuters, are now seeing demand with the opening of new transport stations. “We’ve seen a lot of the larger transactions take place right next to transport hubs. There's been a lot of activity at Paddington station, which has been reactivated by the Elizabeth line,” Dunn said.

Opened earlier this year, the Elizabeth line cuts directly through the city and connects neighbourhoods of London that previously would have taken commuters more than double the time to get to and from on existing Underground lines.

“We've seen a huge flight of occupiers toward assets that sit within the Elizabeth line because it effectively doubles the catchment area of their staff,” Elliott said.

Paddington serves as a good example of the Crossrail’s neighbourhood revitalisation. Previously, the area was convenient only to those living in the western part of the city. “As a result, your catchment [as an occupier] was quite limited,” Elliott said. But now, a commuter could get across town from Canary Wharf, in the east, to Paddington in the west in about 18 minutes, he described. “Suddenly it becomes much more viable.”

The real estate industry and its physical buildings are one of the greatest contributors to carbon emissions, and as climate change accelerates, occupants in London are recognising the need to prioritise energy-efficient and sustainably-constructed buildings in their leasing choices.

In its 2021 report titled “Your Space”, Knight Frank reported that 82% of the 400 occupiers surveyed said sustainability considerations would be “somewhat influential” or “the key influence” in determining their real estate portfolios and strategies over the next three years. But only 37% of respondents said they had a clear target to increase the proportion of their portfolio that has an environmental accreditation, such as BREEAM, LEED or WELL certifications. For more than half of the respondents, less than 10% of their current portfolios have buildings with environmental accreditations.

“There is a huge gap between corporate ambition around sustainability – particularly net zero [operation targets] – and how that ambition is playing out in terms of real estate activity,” said Elliott.

As pressures and legislation changes mount for Energy Performance Certificate (EPC) ratings for buildings, the gap needs to close, Elliott continued, and smart occupiers are making forward-looking decisions based on a building’s environmental performance. Soon in London, no occupier or owner will be able to ignore the necessity for more energy-efficient and sustainable buildings.

Since 2018, commercial buildings have been required to have an EPC rating of ‘E’, but new legislation on the horizon will require all buildings to be rated at a minimum of 'B' by 2030. Buildings that don’t meet benchmarks can’t be leased, “so from an occupier’s perspective, you’re in a building that is obsolete”, Elliott said. “So, in the London market, we are going to see not only a flight towards quality but a significant flight towards sustainably-accredited buildings as well. And while London is well stocked [with environmentally accredited buildings] in global terms, they by no means makeup any more than 25% of the London marketplace. So, there's going to be a bit of a clamor for that sustainably-accredited space.”

Dunn added that the demand for sustainable properties is driven by more than just a need to meet accreditation requirements by the end of the decade, but by a genuine interest in pursuing ESG initiatives.

“Particularly, companies with large public profiles are very conscious of the fact that they need to make sensible decisions for today, but also with an eye on the next five to 10 years of their occupation,” he said.

“Flexibility” felt like the buzzword of 2020, and after an unexpected event like the pandemic, many companies are looking to work room for unforeseen changes or future growth in their occupancy arrangements.

One way the market is seeing this manifest is through a break option in a standard lease. Whereas most office leases signed now in London are for seven to 10 years, Dunn said it’s becoming increasingly common for there to be five-year break options added, especially among smaller occupiers. “On some of the very small lettings, a company might sign on for five years with a three-year break option, and that lease flexibility for them is incredibly important.”

“But it does depend on the size of the deal. We have seen many large occupiers that are still happy to go in for a 15- to 20-year lease – though even some of them are introducing five- to ten-year break options,” he continued. “It could equally be to accommodate potential future growth as well as [contraction].”

And while break options sound like they could cause volatility or an onslaught of vacancies, Dunn thinks it’s positive for the market. “It allows occupiers to right-size their footprint. And more churn in the market is generally a good thing.”

Flexibility in lease terms may also serve as a way for owners of older, less enticing assets to attract tenants in a market dominated by a flight-to-quality, Dunn said. For buildings in which a significant upgrade isn’t feasible, whether due to structural obstacles or lack of capital, Dunn suggests looking to increase incentives.

“Incentives in terms of free rent, a marginal discount or a delayed lease start”, could give owners an advantage, he said. “Although we've seen headline rents at the prime end generally stay pretty healthy, owners of older assets are more likely to acquiesce some flexibility within lease terms, such as a five-year break. We've got this sort of split in the market of the very best and the very worst, and then everything else. You must find a way to differentiate yourself.”

Both Elliott and Dunn noted that increased flexibility and shorter lease terms certainly emerged before the pandemic. “Part of that of course is due to the influence of the coworking revolution over the last part of the last cycle. There is a flight to flex, but it's increasingly about conventional landlords being prepared to do more short-term leasing,” Elliott explained.

Traditional coworking and flex workspace models set up directly by landlords themselves, especially those that combine the desired aesthetic and hospitality service of third-party coworking operators, are set to prove popular among occupiers as well.

“I think [the coworking concept] struggled when WeWork had their very public issues, and that had a knock on the industry. Especially after COVID, coworking just dropped off the list of priorities. But now, we’re increasingly seeing smaller occupiers that would have considered short-term leases become more comfortable going into a flexible provider,” Dunn said.

“These owner-branded, white label products are geared for landlords to be able to ultimately cater to everybody, from a 10-man team up to a 100,000-square-foot lease within one building or portfolio of properties,” he continued.

“Having flex space alongside the traditional leasing world was historically seen as competition,” added Dunn. “Those lines are now being blurred, which is a good thing because it gives occupiers more choices and landlords more services that they can offer. That’s a win-win.”