In brief:  

• The City of London, the capital's traditional business district, is facing dwindling footfall. 
• Office occupancy in London stood at 26.5% in March, according to figures from Remit Consulting. 
• Demand for top properties is still there, but the rest of the market remains very weak. 
• Will the City open up to more residential properties? 

In the new reality of hybrid working, the weekend seems to arrive one day earlier in the City of London. Offices, shops and trains feel mostly empty on Fridays, and Mondays are quieter than they used to be. It is only Tuesday to Thursday where pre-pandemic levels of activity can be reliably seen. 

The reason for this is clear: the City almost exclusively features commercial space. With few to no residents, tourists and commuters make up most of the footfall. 

The data bears this out. Office occupancy in London stood at 26.5% in March, according to figures from Remit Consulting, down from pre-pandemic average estimates of between 60% and 80%. 

High street shops have been the first to feel the effects of this, with more than 40% of the local spend in the City coming from office workers. Reduced footfall has led to the closure of dozens of shops around St Paul’s Cathedral alone. 

As the City’s commercial tenants reassess their footprint in one of the world’s most expensive areas for real estate, the future of the millions of square feet (sq ft) of property in and around the City hangs in the balance. Companies must factor in the new reality of hybrid work, with rising cost of capital and a challenging economic outlook. 

Take 25 Cannon Street as an example. This property sits just across the street from the Financial Times’s Bracken House headquarters. The newly renovated cloister outside front of its main entrance has become a major draw for tourists hunting for pictures of St Paul’s Cathedral, but the building itself — featuring more than 120,000 sq ft of prime office space — has been empty since US property developer Pembroke completed its refurbishment in July 2022. 

Investment firm Brewin Dolphin had signed a 15-year lease for the entire building in 2019 only to scrap the whole operation two years later. 

“Having subsequently evaluated its office space requirements post-pandemic, which includes a more flexible working model for its staff, it has decided to remain in its current office,” the company said in a note in October 2021. It added it had subsequently sub-let several floors at 25 Cannon Street. However, as of June 2, the building remains empty. 

Flight to quality

Developers are still convinced that tenants are not in full retreat, but rather flying to quality. 

“We’re positive because we’re operating at the best-in-class end of the spectrum, which is the only way we can successfully operate given what’s going on,” Darren Richards, head of real estate at British Land, a £3.3bn property developer listed in London, tells fDi Intelligence. “It’s going to be difficult even with ‘ok’ buildings right now,” he adds. 

The latest data show that the office space market in central London (which includes the City of London, as well as other central districts) is already bifurcating. 

While best-in-class properties with top ratings have continued to see positive net absorption rates throughout the pandemic and beyond, net uptake plummeted for everything else, figures from commercial real estate research company Costar show. 

There are several factors that are driving this flight to quality. Beyond status, good offices with good amenities help with talent attraction and retention, particularly in a tight job market; they can also strengthen the case for return-to-office policies. 

“When people are making calls on moving space, they want the very best for their people when they are together: that’s how they think they are going to drive productivity over going back five days per week,” Mr Richards says. “And there is a war for talent that is still going on. Who wants to turn up in a 20-year old building and say: ‘Look, come and work with us’.”

Additionally, the energy efficiency that best-in-class properties can offer is often a must-have for tenants with ambitious net-zero goals in place. This has become increasingly important since the government’s net-zero strategy, approved in 2021, requires  commercial buildings to achieve a grade B minimum energy performance certificate (EPC) by 2030. 

According to Savills, the City of London has the highest proportion of stock above the required level of EPC B at 19% of total stock; that percentage falls at 13% at a country level. 

More on the future of the office:   

• Out of office: US vacancy rates hit record high
• Real estate's new normal? Full factories, empty desks
• Leaving the Silicon Valley
• Europe’s largest business district winks at residential offer

Dark before the dawn

However, things may get worse before they get better. 

Engineering firm Arup worked with the London School of Economics and real estate advisory Gerald Eve to model the future demand of workspace in central London in three different scenarios, characterised by different intensity of hybrid-working arrangements. In the two most optimistic scenarios, where workers attend the office at 65% or 80% of 2019 levels, inhabited floorspace will not return to 2019 levels until the early 2030s; in the least optimistic scenario (50% of 2019 levels), it will take until 2041 to see this level of activity, the November 2022 report shows. 

The growing cost of capital is also another major issue of concern. Low interest rates sustained very strong investment levels until the end of 2019, but those days are long gone. Investment has been consistently subdued since the central banks started hiking interest rates at the beginning of 2022, further shirking the development pipeline for new office space, Gerald Eve data shows. 

The market has taken notice. The portfolios of all the major UK-listed property companies took a hit in 2022. While rents at the top of the market increased, they were not enough to keep up with the 10.5% inflation rate seen at the end of 2022. 

But lower valuations and strong demand for prime office space, combined with a constrained development pipeline, remain a major opportunity for those specialised firms developing office space at the top end of the market. 

“So much of the London office stock needs to be upgraded, there’s a big opportunity to create the best-in-class buildings,” says Gerald Kaye, CEO of Helical, a listed property developer that focuses on prime properties in London. “I think we are going to be busy over the next few years.” 

Helical is developing 790,000 sq ft of prime office space, to be completed between 2025 and 2029 — “our most significant for a number of years”, Mr Kaye said in May. 

All things being equal, the flipside to the City’s flagging footfall of the past few years is the creation of more vibrant local economies in other London boroughs as workers spend more time and money with local businesses.

However, this is hardly the beginning of the end for the City of London. The area has experienced many peaks and valleys over the years: just 40 years ago, pundits were reviving “the spectre of decentralisation” and “[predicting] that City specialists will be working from computer terminals at home in the future”, according to a Financial Times article in September 1985.

Both predictions came to pass, and yet the City has not lost its gravitational pull. It adjusted its offer of office space to the ever evolving needs of telecommunications and digital technologies. It accommodated the internationalisation of the banking and financial industry as a whole. It found new tenants in emerging sectors, such as tech.

But in a world that is cutting down on commuting, betting exclusively on commercial properties may not be the way forward. Local policy-makers have already commissioned the building of 1500 new homes in the Square Mile by 2030 after heavily restricting such developments for years. They are also beefing up the local offer for leisure and entertainment activities. 

It is still far-fetched to think the City will transition to a fully fledged live–work–play model, but it has become clear that a work-only model is not going to cut it any longer.

This article first appeared in the June/July 2023 print edition of fDi Intelligence