A tilt to refurbishment and ‘flight to quality’ drive stronger demand for Grade A accommodation

London office development pipeline is forecast to grow next year, with 2023 likely to be the post-pandemic ‘Year of the Catch-up’ on completions

Developers expect a maturing approach to hybrid working to reduce the requirement for office space per head by 10% vs pre-pandemic levels, but increased demand for high quality space set to grow

Majority of developers (81%) report their new developments will be net zero by 2034, but want greater clarity around net zero targets and legislation

Overall, cost continues to be the number one drag on construction activity overall.

A desire for high quality office space is driving increasing demand for Grade A accommodation in ‘a flight to quality’, according to the Deloitte London Office Crane Survey.* As a result, refurbishments remain a strong feature of new construction activity, representing 26 of the 31 new starts during the survey period.
In the six months to September, the total volume of refurbished space was 1.7 million sq ft. To attract workers back to the office, firms are demanding more high quality Grade A office space, leading to a concentration of activity in the City, West End and Midtown areas of London where there is a relatively large stock of existing buildings ripe for refurbishment. In addition, ESG concerns around demolition, coupled with the financial risk of new build projects appear to be making refurbishments more attractive.
Margaret Doyle, chief insights officer and partner for financial services at Deloitte, said: “The past year has been characterised by an uptick in post-pandemic refurbishment activity. Looking forward, 2023 could turn out to be the ‘Year of the Catch-up,’ delivering the highest volume of new office space for 20 years. However, this will depend on whether supply chain disruptions, labour shortages, financing difficulties or material price inflation cause further completion delays. Looking further forward to 2025, we anticipate it will be the ‘Year of the Investor’ as renewed pressure on stock stimulates rental growth, creating a wave of fresh opportunities for developers.”
Pipeline
During the survey period, 31 schemes with a total volume of 2.5 million sq ft started between April and September 2022. This represents a 6% rise in volume from the previous survey (2.3 million sq ft), but remains below the ten-year average (2.9 million sq ft). Completions are also up by 71% from the previous six months, with nearly 3.0 million sq ft delivered across 29 schemes during this latest survey period.
However, following a sustained period of optimism, developers are beginning to grow increasingly cautious about the immediate outlook for the London office leasing market. Only 36% reported improving leasing demand over the six months to September 2022, compared to 45% who reported softening demand over the same period. This caution follows a period of relatively buoyant leasing activity after the sharp declines witnessed in the wake of the pandemic. Most developers (70%) expect the shift to hybrid working will reduce the overall requirement for London office space per head by 10% in the short-term compared to pre-pandemic levels, driven by a maturing approach to how and where people work.
Net zero commitments
More than three quarters of developers (81%) say their new developments will achieve net zero by 2034. However, over half (54%) also said their developments would only reach net zero after 2030, in contrast to 70% striving for 2030 or earlier in the same period last year.
Philip Parnell, partner and real estate climate & sustainability lead said: “With tenants seeking better quality accommodation offering demonstrable ESG credentials, developers are focusing increasingly on the refurbishment of existing stock as a means of addressing ‘stranding risk’. Net zero targets and legislation to support the commercial case for net zero development remain unclear and it remains to be seen whether the current macroeconomic headwinds will stifle progress. However, with both occupational and investor stakeholder pressure mounting we expect the shift towards greater alignment from developers with the ESG agenda to continue.”
Cost challenges
Almost nine in ten developers (91%) continue to rate construction costs as their leading challenge, albeit a smaller proportion than seen in the previous survey (100%), as concerns around the availability of funding grow. More than a quarter of developers (27%) cite availability of funding as an issue, compared to none in the previous survey, with the increasing cost of materials, coupled with rising energy tariffs, driving up the price of construction.
Sophie Allan, director, real assets advisory at Deloitte, said: “Construction costs are likely to remain a major challenge over the near term. Likewise, rapidly increasing debt funding costs will continue to weigh on scheme viability where sites have already been acquired. This, along with inflation in tender prices, will put pressure on land prices going forward.”
The evolving city
The legal profession has taken the largest proportion of under-construction pre-lets, representing a third (33%) of total pre-completion let volumes. Meanwhile, by contrast, the share of pre-completion letting volumes taken by financial services firms has shrunk by almost half in under five years to 17%. The overall share for these two sectors has grown since the last survey, from 44% to 50%.
Margaret Doyle said: “The decline in financial services pre-completion letting volumes is balanced by significant growth in the legal sector. In many cases, office moves have been driven by a desire to move to accommodation with stronger ESG credentials and helps support employee wellbeing. The preference for higher quality Grade A space that we see across sectors is one we expect to endure.”
 

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Note to editors
*Conducted twice a year, the London Office Crane Survey analysed office construction data over the six months from April to September 2022 and included a survey of London’s biggest developers conducted in September 2022.
About the London Office Crane Survey:
*Deloitte’s London Office Crane Survey has been running for 26 years and is updated every six months, with the last survey published in May 2022. The data in this report is correct as of September 2022.
The Crane Survey covers seven major central London office markets known as submarkets: The City, West End, Docklands, King’s Cross, Midtown, Paddington, Southbank, as well as three emerging submarkets: Vauxhall-Nine Elms-Battersea (VNEB), White City and Stratford.
The first Crane Survey in London was published in 1996, focusing solely on the West End. The London Office Crane Survey as we know it today was first published six years later in Summer 2002, with the addition of our emerging sub-markets in Summer 2016.
The London Office Crane Survey is the definitive review of office construction in central London and regarded as a barometer of developer sentiment and future office supply. The report measures the volume and impact of office development (new build or significant office refurbishments of 10,000 sq ft or more) currently taking place across central London and analyses the pipeline of future development over the next four years.
The Crane Survey also features a ‘Construction Cost and Workload Sentiment Survey’ – a survey of main and subcontractors, capturing market sentiment on workload and price.
Deloitte’s commercial property research team is focused on producing thoughtful and insightful publications, as well as comprehensive bespoke reports for investors, developers, and occupiers. 
www.deloitte.co.uk/cranesurvey
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Deloitte LLP is a subsidiary of Deloitte NSE LLP, which is a member firm of DTTL, and is among the UK’s leading professional services firms.
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