Business Review
Office sector
Leadership in London Offices
- £5.4 billion invested
Our strategy for the offices portfolio is to concentrate on prime assets in the City and West End of London where there are favourable supply and demand imbalances, fuelled by increasing occupational density and steeply rising building replacement costs. Despite recent credit market turbulence, London’s global position as a business centre is well established and we consider London is the right place to be over the medium term.
Our customer focus is on providing the right accommodation to meet the requirements of the financial and business services based in the capital. We build on this by offering ‘best in class’ property management, from estate services through to development of new accommodation. Proactive asset management aims to tailor what we offer to customers’ changing needs.
In allocating and recycling our capital we recognise that the office market is cyclical. We manage our exposure accordingly and, in anticipation of the current point in the cycle, have sold some £2.7 billion of office investments over the last three years, taking advantage of the previously strong market to achieve sale prices ahead of valuation. After offsetting this by purchases and development spend, we made a net disinvestment over that period of some £1.2 billion, overall boosting our performance.
As a result, our office portfolio weighting in the City has been managed at 77% and increased in the West End to 21%.
The reshaping leaves us with a well positioned prime London office portfolio:
- 4.5 million sq ft in the City;
- 1.5 million sq ft in the West End;
- investments over 99% occupied;
- weighted average lease length of over 11years (to first break);
- valued on the basis of a net equivalent yield of 5.8%;
- 9% reversionary income (in addition to rent-frees and minimum uplifts);
- an average rent of only £45 per sq ft, against an average headline ERV of £51 per sq ft, so we expect to achieve value added rental growth; and
- our investment in the Canary Wharf office estate, through our shareholding in Songbird Estates.
The principal assets within the office investment portfolio are:
- Broadgate, EC2, the premier 4 million sq ft City of London office estate, valued at £2.7 billion. Broadgate comprises 15 office buildings plus the recently completed 201 Bishopsgate and the site on which we are developing The Broadgate Tower – a distinctive environment for some of the world’s largest corporations and leading professional practices. Each building provides efficient working space of the highest standard while providing flexibility to allow occupiers to change floor layouts or install new technology. A wide range of retail outlets and excellent public transport connections contributes to Broadgate’s appeal to our customers;
- Regents Place, NW1, at the north of the West End, valued at £702m. A distinctive mix of five buildings provides nearly 1 million sq ft of office accommodation, complemented by public spaces, retail and leisure elements, with significant public transport links;
- The Willis Building, EC3, a 496,000 sq ft office development recently completed by British Land. The 28 storey building occupies a prime City site opposite Lloyds of London and is let to the Willis Group; and
- York House, W1, a development completed by us in early 2007 providing 90,000 sq ft of offices with adaptable and efficient floor plates, fully let within a year of its completion.
Asset management
We have worked hard during the year to add to performance.
Sales of £828m have been achieved at an average net equivalent yield of 5.0% (net initial yield of 3.1%), primarily aimed at managing our weighting in the City at this point in the cycle.
1.1 million sq ft of lettings and lease regears, including notable pre-lets at our City office developments recently completed or due for completion during 2008, and achieving record rents at Broadgate, Regent’s Place and York House.
Rent reviews in respect of over 1 million sq ft across the office
portfolio have been agreed since March 2007, settled at well
above ERV and producing an 11% increase in rent. These include
agreement since the year end of a package of rent reviews, including
elements of lease variation, in respect of 450,000 sq ft in three
buildings at Finsbury Avenue, Broadgate, to show a £1.8m
per annum uplift equivalent to around £4 per sq ft.
Our office development activity during the year has both de-risked and realised profits from the programme. We have completed three City projects this year: Ludgate West, 201 Bishopsgate and Basinghall Street, together 745,000 sq ft of office accommodation, generating significant profits on cost.
In addition to the success in letting these projects mentioned above, we have achieved sales of the completed Ludgate West and Basinghall Street, such that 70% of the London office development projects with completions in 2007 and 2008 have already been pre-let or sold.
The Broadgate Tower will complete later this year. The office accommodation remaining available to let in the Tower and at 201 Bishopsgate (together with the 8,000 sq ft available at Broadgate) represents in the region of just 5% of our office portfolio.
The Ropemaker and Osnaburgh Street developments (details of which are shown in other sections of this report) are on schedule for completion in 2009, producing high quality buildings in both the City and the West End. We are also pleased to have received a resolution to grant planning consent for 501,000 sq ft of offices and residential at the North East quadrant, Regent's Place, a project which will further assist in our ambition to have a balance in the office portfolio between the City and the West End.
Investment market
The first half of 2007 saw high levels of investment activity in offices, with yields at relatively low levels. Later in the year, turnover slumped and there was little activity as investors reviewed their positions in the changing financial market conditions. Prime yields moved out some 100 bps, reflecting views of increased risk factors across most assets. The early part of 2008, our Q4, saw some activity return to the market and yield compression has slowed. In these market conditions, it was no mean feat for us to carry out sales across the year of £828m and overall nearly 4% above March 2007 valuation.
The direction and size of yield movements going forward is uncertain as sentiment continues to be volatile, in respect of both the credit market and the occupier market which are the main determinants. On a positive note, significant pools of capital are seeking investment opportunities in London offices, including from overseas. Investors generally see the sharp increase in yields as a buying opportunity and share our belief in the prospects for prime offices over the medium term, due to London’s competitive advantages in attracting financial and business services. The growth in these sectors, and so their requirement for the best office accommodation, is likely to outstrip overall levels of growth in the economy. And prime London offices offer significant investment liquidity.
Secondary assets will be at greater risk of higher levels of outward yield shift. Investors will analyse the relative risk weighted returns and prospects of prime versus secondary, including refurbishment voids and reletting costs required.
British Land’s office portfolio is prime and offers strong cash flows, valued on a gross initial yield, topped up for rent-free periods and minimum rental uplifts at first review, of 5.8% in the City and 5.2% in the West End.
Occupier market
During this current year demand from office occupiers is expected to reduce. Employment in the financial and business services sectors is estimated (by CEBR) to fall by around 2% in 2008/9 and then grow again by c. 3% per annum through to 2012. Vacancy rates for London offices are expected to rise in the short term as developments under way are completed over the next couple of years, at the same time as the phase of weakening occupier demand.
It is positive that this will be based on low current vacancy rates for Grade A accommodation in the West End and in the City, both at 2.6%, a level which is well below the 10-year average. Also, take up in the first quarter of 2008 was at a reasonable level and enquiries indicate a continuing level of occupier interest.
Accordingly, it is unlikely that we will see a repeat of occupier market conditions and vacancy rates seen in London offices during 2002/3, since the majority of customers are operating in offices at full occupancy and with limited scope, at present, for release by them of accommodation in the market. In addition, the new accommodation produced from developments not yet started is likely to be curtailed, as the financial market turmoil and reduced availability of debt, together with rising construction costs, will reduce their viability.
This limitation on supply, coupled with the forecast pick-up in City employment is producing a more encouraging outlook for 2010 onwards.
So we have a reasonably positive outlook for the occupier market in the medium term, although in the short term we do expect letting incentives to increase and there are the first signs in the City of headline rents softening.
As to occupier preferences between City and West End locations, affordability will become an issue for some whose first preference would be the core West End. Rents there are at a high, in the region of double the rents for fringe West End and City. Occupiers are likely to reconsider their requirements for such central West End positions and perhaps look at moving to the City or mid-town locations.
British Land’s office portfolio has very high occupancy levels, of 99.7% in the City and 99.8% in the West End, including the small amounts of accommodation we have subject to asset management initiatives and under offer. As noted above, 70% of our 2007/8 completions of London office developments have been pre-let or sold, and we have limited areas available for letting. Our ongoing developments are well spread both as to timing and between the City and West End.
On this sound base we will continue to concentrate our efforts, in a market where competition for occupiers will be tighter, on providing the best space to the market. We are well positioned to ride out this cycle and we remain positive regarding London’s competitive advantages as a global financial and services centre.
To minimise energy consumption at York House, special sensors monitor activity levels in offices and adjust the lighting accordingly.
