London's office supply challenge

Office occupiers are placing an ever-increasing focus on high quality, highly sustainable buildings.

But they now face a challenge to find the space they require in core, well-connected central London locations. We assess the market dynamics that will be important in 2025.

The race for quality

Regulation continues to drive the race for quality space. The tightening of Minimum Energy Efficiency Standards (MEES) is focusing demand firmly towards EPC grade A and B buildings in order to achieve compliance from 2030 (when an EPC rating of B is scheduled to become the legal minimum). As a result, buildings below a B rating are already largely unlettable.

However, occupier preferences are becoming a more important driver, as corporates increasingly use high quality, sustainable buildings to assist their recruitment, retention and productivity strategies, as well as provide broader employee wellness benefits. In addition, occupying highly sustainable buildings helps them meet sustainability targets and is increasingly used to create a positive corporate image.

A further factor is the European Union’s Corporate Sustainability Reporting Directive (CSRD), which aims to harmonise and improve corporate sustainability reporting within the EU. Notably, UK companies with subsidiaries or trading activities in the EU will need to comply with the Directive.

The evolving nature of office use will only serve to increase the importance of sustainability and broader quality factors. For example, the rise of AI-related jobs will mean higher quality, higher paid functions will be undertaken in offices, and occupiers are therefore likely to invest more in them.

The supply gap

A constrained volume of office development since the pandemic relative to grade A demand means there is now a considerable shortage of prime supply in many of central London’s districts. Some locations, such as Mayfair and St James’s, have a long-standing undersupply issue due to their inbuilt physical and planning constraints. But even the core City of London, which is more able to accommodate large-scale, high-rise, schemes, is now running low on quality floor space.

In addition to the shortfall of immediately available space, there are only limited options to lease buildings currently under construction. A high number of pre-lettings, in reaction to low immediately available stock, have taken much of the potentially available new supply out of the market. We have also seen an increasing number of developments geared towards the life sciences sector.

London’s office stock is clearly not aligned with tightening MEES regulations. Our research shows that 12% of London’s office buildings have an EPC rating of F or G, and are therefore unlettable today. 58% are D or below, and are expected to become unlettable from April 2027 when it is proposed that commercial properties must have an A, B or C rating. 83% are C or below, so would become unlettable in 2030 unless remedial action is taken (or an exemption applies). At the other end of the scale only 17% of London’s office buildings achieve a B rating or better, which is where occupier demand is firmly focussed. Whilst it is important to remember that these figures show the number of buildings rather than the total floor area (and lower quality ratings are probably focussed on smaller buildings), they highlight the scale of the challenge to raise the energy performance of London's stock of office buildings.

Low supply is reflected in strong rates of rental growth, with prime rents rising by an average of over 7% over the year to Q3 2024 across the West End, Midtown and City markets. Demand is certainly robust, but this increase in rents is very much supply led.

Supply shortages have caused a ‘ripple effect’, with demand displaced from core locations to other districts within central London - although there are now few districts where quality supply is plentiful (a key exception being Canary Wharf). As an example, Covent Garden has seen significant rent rises, with £87.50 per sq ft per annum now the benchmark prime headline rent, compared with £82.50 psf at the start of 2024. This is not purely down to a lack of supply, but is also a function of recent developments setting new benchmarks for this district in terms of quality, providing a new product not previously seen in this location.

The oversupply challenge – a shift towards refurbishment?

In tandem with the dearth of prime office space, there is a considerable oversupply of lower quality space as total occupancy has reduced. ‘Stranded assets’ which are not viable to be upgraded will continue to provide opportunities for repurposing. This also presents a broader opportunity to increase the stock of other uses that drive footfall and economic activity, and that may work with existing office layouts – for example education, health, hotels, and student accommodation.

Planning policy is increasingly steering development towards refurbishment or repurposing. The London Plan now favours refurbishing over demolishing office buildings, and mandates Whole Life Carbon Assessments for major projects, ensuring that both embodied and operational emissions are considered during the planning and design process.

The outlook

We expect the current limited supply of immediately available grade A stock across much of central London to decline even further in 2025. At the same time, the outlook for demand remains positive, given greater political certainty in the UK and the US, continued economic growth, and employment growth in financial and business services. In addition, office occupancy levels have broadly stabilised, and together with improving job creation, we have now passed the post-pandemic period of corporate floorspace downsizing.

Developers will continue to face challenges, including the cost of finance, rising construction costs, and planning challenges, not helped by some recent building contractor insolvencies. On the positive side, borrowing and construction costs should reduce in 2025, and the supply / demand imbalance and further rental growth are a positive for developers. However, the volume of development is unlikely to see a significant acceleration, and the supply / demand imbalance will continue to be a feature in 2025.