View of Manhattan: positive economic prospects will give a boost to the New York office market.
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A planet with three stars

Tokyo, London and New York City stand unchallenged at the top of the global office market rankings – with good reason. They are right at the heart of the global economy.

Standing a good 200 metres tall with a facade containing 4,900 windows and 102,190 square metres of office space on 45 floors inside, the HSBC Tower in Canary Wharf, London’s biggest office building by area, is a jewel for investors. The sovereign wealth fund of the Emirate of Qatar has bid more than £1.1 billion for this building, which houses the headquarters of the British bank HSBC. If the present owner, the South Korean state pension fund, accepts that offer, it will be the highest price ever achieved for an individual office property in London. That is no coincidence, because office buildings in London are attracting investors with the prospect of good rent increases. According to the Jones Lang LaSalle (JLL) property consultancy, in the third quarter of 2014 tenants in the prime West End district paid £105 per square foot – an increase of 11 percent in the past 24 months. Analysts are actually expecting rises of up to 25 percent for office rents in the city’s A-locations by 2017. But the British capital is not the only place that is drawing investors: alongside London, New York City and Tokyo are the top office-letting markets in the world, because, as the most important financial marketplaces for their respective continents, these three cities have been attracting international capital like magnets for decades. Major banks, private companies and institutional organisations all maintain a presence in these three megacities, so as to be close to the heartbeat of the global economy. 

Tokyo office rental rates still have potential to rise.
Fred Uruma, CEO, Touchstone Capital Group

In return for this, they willingly accept that when the heart of the world economy starts to falter, these are the places where you will feel it especially quickly and sharply. For instance, in the recent financial crisis, major banks were forced to close down whole divisions and to cut both staff numbers and office space. There were also investors who lost money and sold off buildings for less than they had paid for them. As a result, the office market collapsed. However, investors know that it is possible to recover just as rapidly as they are plunged into the depths, and the recent financial crisis only confirmed this rule. For instance, the listed real estate company New York REIT paid the equivalent of €252 million last summer for a twelve-storey office building in the New York district of Chelsea, for which the previous owner, Savanna Real Estate Fund, had had to find just €57 million in November 2012. In London’s West End, according to the Savills consultancy, buildings with a total value of €3.1 billion changed hands for more than ever before in the first half of 2014. Tokyo, too, seems finally to have put its long phase of economic stagnation behind it. So, there are many signs suggesting that prices of office lettings in all three financial centres have not yet reached their peak.

In Tokyo, office rents are just beginning to rise again: according to the Cushman & Wakefield (C&W) consultancy, office owners in A-locations were able to ask the equivalent of roughly €74 per square metre per month in 2014; analysts expect growth of more than 8 percent by 2016. “Tokyo office rental rates still have enough potential to rise”, says Fred Uruma, CEO of Touchstone Capital Group in Tokyo. The government’s political and fiscal reforms have slowly started taking effect, and the property market is recovering. “Office rents at present are still about 25 percent below their former peak”, Uruma explains. In all three cities, general conditions suggest that domestic companies will grow in the next two years and, accordingly, will invest in more office space. Although office rents in prime areas of London and New York had already risen sharply in some cases in 2013, nobody expects the present cycle to come to an end soon. The market in Tokyo is only just picking up, but JLL expects moderate growth for London and New York in the coming two years.

Canary Wharf Tower in London’s financial district of the same name: office rents in the British capital are still rising.
Margaret Larys / agefotostock / Avenue Images

Prices driven by shortage of space

There is good reason for this: in all three cities prices are being driven by a shortage of vacant, new office space. The greater Tokyo area may be, at 86 million square metres, the biggest office property market in the world – larger than London and Manhattan combined – but the metropolitan region of the Japanese capital is also home to 37.5 million people, most of whom commute daily into the centre to work. There, skyscrapers stand in very close proximity to each other. “In Tokyo there are just very few places where you can buy land and build on it”, Fred Uruma says. Instead, what is happening now is that old office buildings are being redeveloped or several small units are being put together to form a single huge building. These construction projects cost up to €5 billion. Nevertheless, they will do little to ease the pressure on Tokyo: according to C&W, office vacancy rates will remain far below 6 percent in 2015 – and at that level, Tokyo is a letter’s market. Many office buildings belong to Japan’s five biggest real estate companies: Mitsui, Mitsubishi, Sumitomo, Tokyu and the Mori Building Company. However, the positive trend is also encouraging institutional investors and international real estate funds to position themselves there. For instance, Pacific Century Place Marunouchi in central Tokyo was bought in October by GIC, Singapore’s sovereign wealth fund, for the equivalent of €1.36 billion. Union Investment secured J6 Front, an office and business property, in 2014 for the equivalent of €127 million. That Grade A building, comprising 4,939 square metres of renting space, has been fully let to six Japanese companies. Many properties change hands behind closed doors. “The office-space market in Tokyo is not at all as transparent and easy to enter for foreign investors as  London or New York”, Uruma observes.

Not many newbuilds

In New York, too, office rents are determined by the low vacancy rate. For this year, the property advisors at the North American branch of Bankhaus Metzler expect a level of vacant office space of just 6 percent. “US cities with such a low vacancy rate are landlord markets”, says Zeb Bradford, Chief Investment Officer at Metzler North America in Atlanta. At the same time, the pipeline of newbuilds is filling only slowly. Although the Hudson Yards building complex is going up on the western edge of Manhattan, providing 15 modern high-rise buildings with a lot of office space in the coming years, most of that space will not be ready for occupancy before 2020 – and nobody is expecting a rise in vacancy rates before then.

Pacific Century Place Marunouchi in Tokyo: Singapore’s sovereign wealth fund has invested the equivalent of about €1.4 billion.
Jochen Tack / imageBROKER / OKAPIA

London’s office market is not expecting any breathing space, either. “We have relatively low construction starts, which will continue to protect us from oversupply for the time being”, says James Goldsmith, Director Central London Markets at Savills. Construction is taking place here and there: it is planned to create office space totalling 1.9 million square metres in the City and the West End in the next four years – some of it in new buildings, some in premises that have undergone major refurbishment, meeting modern environmental requirements and the growing desire for open-plan offices. According to Savills, leases have already been signed for 20 percent of the properties that have not yet been completed, which is an unusually high figure. New York and London, unlike Tokyo, are very transparent markets and, therefore, magnets for investment. “The New York office market is very open to foreign capital. The possibilities range from between 50 million for smaller buildings to large, 3-billion-dollar deals”, observes Zeb Bradford at Metzler.

The New York office market is very open to foreign capital. The possibilities range from between 50 million for smaller buildings to large, 3-billion-dollar deals.
Zeb Bradford, Chief Investment Officer at Metzler North America

All groups of letters are represented in New York, from sovereign wealth funds to private equity firms and individuals. In London, too, the ownership structure is publicly available, and the tax system is open to international investors. “The only real barrier is the price of a building”, notes James Goldsmith. There is, however, an interesting new trend emerging in London and New York: the short supply of high-value class-A buildings in central locations is prompting tenants in both cities to switch increasingly to class-B buildings in less expensive areas. This is not only causing rents in that segment to rise but also, in the longer term, boosting the volume of the whole office property market – and opening up new investment opportunities. These new submarkets are being fuelled by a change in the tenant mix. The bulk of office space in London, New York and Tokyo is still dominated by institutions, banks and financial service providers. However, for the past few years, TMTs (technology, media and telecommunications companies) have been pushing their way into these cities, and are changing the market because they like areas that are “in”, rather than traditional office districts.

“The newer industries prefer buildings of lower quality in fringe locations which they see as modern and trendy”, says James Goldsmith. While the turnover in office space rose by 5 percent in the first half of 2014 in central London, in the outskirts the Savills analysts observed an impressive increase of 23 percent. In New York, too, TMTs are picking up the office space that the crisis forced the finance industry to give up. “Young employees want to work in urban surroundings with older, industrial-looking buildings converted into offices. This pushes edgier districts”, says Zeb Bradford at Metzler. One such district is Midtown South, where, according to JLL, the vacancy rate actually slumped in 2014 to 3.7 percent. In Tokyo, meanwhile, TMTs are only just starting to arrive. “We are the most developed country regarding public transport, but concerning the infrastructure for internet and telephone services, we are ten years behind London and New York”, says Fred Uruma. The recent strong development of letting figures means that confidence in these three top office markets is growing. The fact that rates of new construction are only moderate is a sign that demand will continue to outstrip supply in the coming two to three years. This will mean growing office occupancy rates and rising rental income for letters – which will cause these three stars in the office-letting firmament to shine even more brightly.


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