Returns from office investments in London’s West End, surged to 23.3% in the 12 months prior to the end of June.

According to the latest IPD/Colliers International West End Office Investment Report, this was the strongest performance in over four years, reflecting an occupier market that is strengthening in line with the pick-up in the broader UK economy.

The return was more than double the 10.3% y/y posted in the previous 12 months. It highlights the dramatic improvement in the market since the lull of 2012 and early 2013, and reinforces the position of the West End as the UK’s top-performing office investment location.

While sustained buying – particularly from overseas investors – has been increasing capital values in recent times, the market is now seeing substantial rental growth which is also driving returns.

During the first half of 2014, rents surged by 5.7% h/h, reflecting an annualised growth of 8.7% y/y between June 2013 and June 2014. As a result, rental values in the West End are now only 5.5% off their previous cycle peak in March 2008.

Colliers Co-Head of Central London Investment, John Olney, comments: “With an improving economic environment, growing occupier demand and supply remaining constrained, the only consequence can be continued rental growth.

“In circumstances such as these, rents have a tendency to ‘jump forward’ rather than increase incrementally. Accordingly, the market starts to see rents increasing by movements of, say, £5-£10 per sq ft rather than £1 or £2 per sq ft that we have seen during the more muted demand environment of the past three years.

“These are the conditions where double digit annual rental growth becomes possible. The IPD West End office sample is already showing rental growth in the 12 months to June 30 of 8.7% and we expect this to break 10% next year.”

There was £5.1bn of transactional activity in the West End market during the research period and for the first time average capital values broke through the £1,000 per sq ft mark to stand at £1,112 sq ft.

However, with London’s prime residential market booming to reflect values of over £4,000 per sq ft, an increasing number of investors also have an eye on converting office buildings into homes.

Colliers International, Co-Head of London Agency and Development, David Hanrahan, commented: In 2013, just under 800,000 sq ft of West End offices were converted to homes and there are unimplemented consents which could remove a further 1.8m sq ft from the market if they proceed.

“This trend plus growing occupier demand and a low level of development has created a situation where vacancy rates are now at 3.8% - their lowest level for 13 years. With top rents in core West End locations now over £120 per sq ft, some occupiers will have to look beyond the West End for space.”

The report notes that there is now some evidence of profit-taking as investors who bought into the market in the last 2-3 years look to crystallise capital gains.

However, investor demand for West End assets remains very strong and the report expects it to strengthen in an active market which provides both selling and buying opportunities.
 
Colm Lauder, Senior Associate at IPD, the real estate arm of MSCI, comments: “The West End has now experienced a sustained period of recovery with capital values growing consistently for 20 quarters since September 2009. Returns have averaged 4.3% quarter-on-quarter during that period.

“Similarly, market rents have grown continuously in the West End since March 2010, making it one of the first UK office markets to return to real growth following the crash of 2008-2009.”