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(Bloomberg) -- When UBS Group AG agreed to rent a new headquarters in London five years ago, the U.K. economy was struggling to emerge from a recession and the financial district’s banks were firing workers following the global credit crisis. As the Swiss lender’s building nears completion, its timing looks shrewd.
UBS secured a rent of 54.50 pounds ($82.44) a square foot in the City of London financial district’s biggest leasing agreement since 2002. Since then, a rebounding financial industry has collided with a dearth of new offices, pushing average rents up to about 8 pounds a square foot more than UBS will pay. Broker CBRE Group Inc. forecasts an increase of 12 percent this year.
Demand for offices in the City is expected to outstrip supply for the next several years because construction plummeted after the financial crisis, creating a shortage of space coming onto the market today, according to Deloitte Real Estate. Just one building being completed this year has more than 100,000 square feet (9,300 square meters) that’s still available to lease, said Chris Vydra, an executive director at CBRE.
“Development came to a halt completely and you can’t turn buildings around quickly,” Martin Jepson, president and chief operating officer of Brookfield Property Partners LP’s European unit, said in a Jan. 9 interview. “When you take into account planning, construction and everything else, it’s a four- to five-year process to start from scratch.”
Half of the space being built in the City of London and the adjacent technology district that includes Shoreditch has been leased in advance of completion, according to Deloitte Real Estate. That limits choices for companies such as law firm Ashurst LLP and broadcaster ITV Plc, which are each seeking more than 200,000 square feet in the district, according to people with knowledge of the situation who asked not to be identified because the matter is private.
Jefferies Group LLC is also seeking a new headquarters in the City of London in excess of 200,000 square feet, according to two people familiar with the matter. Samantha Randall, a spokeswoman for Jefferies, declined to comment, as did Maria Souvorov, a spokeswoman for Ashurst.
While banks cut workers in the wake of the 2008 financial crisis, insurers and technology companies expanded, leasing space in the few skyscrapers such as 20 Fenchurch Street and the Leadenhall Building that began construction in 2010. Companies including insurer Aon Corp. and Liberty Mutual Group Inc. leased space in the towers prior to their completion. That contributed to a shortage of offices when bank hiring rebounded and other businesses decided to expand as the economy started to improve in 2013.
Financial services job vacancies in Canary Wharf and the City rose 18 percent in 2014 from a year earlier to 33,063 as hiring is returning to “pre-recessionary” levels, recruiter Astbury Marsden said on Jan. 5.
Landlords that own City office properties or are developing buildings will see the strongest rental growth in 2015 in the eight years through 2018, CBRE said. It estimates that the district’s vacancy rate will fall to 3 percent in 2018 from 4.8 percent at the end of last year.
In 2015, rents for the best offices in the district will climb to 70 pounds a square foot, CBRE predicts. The level now is 2 percent above the last peak in March 2008, researcher IPD said. Occupiers agreed to new leases for 12.4 million square feet of office space in the U.K. capital last year, the most since 2007, according to broker Cushman & Wakefield Inc.
Landlords cut average rent-free periods granted to new tenants to 21 months from 24 months in the center of the City last year, according to data compiled by Elaine Rossall, head of central London research at Cushman & Wakefield. The period shrank to 18 months from 24 months in the surrounding Clerkenwell and Shoreditch districts.
“The bigger the tenant, the longer it takes to find a building,” CBRE’s Vydra said “If there isn’t anything available, they risk ending up with something that isn’t quite right, or they have to stay put.”
UBS will lease a new 700,000 square-foot building at the Broadgate office complex from landlords British Land Co. and GIC Pte. The Swiss bank agreed to rent the space five years ago and signed the deal in 2012. The building will be completed in mid-2015 and as many as 6,000 workers will begin moving into the property in the fourth quarter of 2016 after a 125-million pound fit-out by ISG Plc.
“Whilst 2010 was a period of significant volatility, the deal still made sense,” Rob Bullough, regional head of real estate and workspace at UBS, said by e-mail. “Given the state of the real estate market at the time, we did realize that we were sitting on a unique opportunity.”
The building will have three trading floors initially, a 250-seat auditorium, external terraces, a gym, a staff restaurant and more than 500 bicycle spaces, he said. The Broadgate deal was the largest City leasing agreement since Allen & Overy pre-leased 750,000 square feet at Bishops Square in the third quarter of 2002.
Only 12 months of supply is currently under construction in central London and demand for the best space is expected to beat supply for three more years, Deloitte Real Estate said in November. While the space squeeze is pushing up rents, it may not be enough to prompt lenders to bet on new projects in the City of London. Buildings under construction now may hit the market just as rental growth slows.
“Finance is coming back into the market, but there’s still not a lot available for anything of a speculative nature,” Jepson said. Lenders “had their fingers burnt in the past and it’s an easier proposition to be lending money on an income- producing asset.”
The space shortage could quickly turn into a glut as construction ramps up. During the next five years, 135 buildings totaling 22.5 million square feet could be completed in the City of London and the south bank of the River Thames, according to broker GVA. Building projects underway in the financial district account for three quarters of the office space under construction in London according to Deloitte Real Estate.
Famine to Feast
“The development and real estate finance market will react and start building again,” Vydra said. “By creating that extra supply, growth in rents will likely halt in 2018 to 2019.”
Investors have been keen to buy into the future rental growth and as a result City of London office building yields fell below 4.25 percent in December from 4.75 percent a year earlier, broker Jones Lang LaSalle Inc. said. Yields, a measure of annual rent relative to the cost of a building, tend to fall when prices increase.
Brookfield bought six properties in the City from Hammerson Plc in 2012 for 518 million pounds, betting that demand for offices would grow as the economy improved. Amazon.com Inc. agreed to rent about 400,000 square feet at one of the sites on the northern fringe of the City in September.
At the time, “you could see that supply was already starting to look limited in the years ahead,” Jepson said. “As long as the market got back to the status quo in terms of demand from tenants, you could see the opportunity was there.”
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