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Commercial sector puts caution first

Office construction will remain healthy this year but new orders are set to slow. By Allan Wilen

Office construction has been one of the fastest expanding areas of construction activity over the last three years and a key driver of industry growth.

It has risen by more than 50 per cent since 2004. The sector has been underpinned by strong occupier demand for office space, market expectations of further growth in demand and investors chasing spiralling capital values.

But the continued crisis in global financial markets is now casting a shadow over the sector’s prospects as developers fret over its implications for occupier demand and securing project funding has become more difficult and expensive.

Low interest rates and readily available finance have helped drive up property values including offices over the last three years and in turn fuel the rapid expansion in office construction activity.

Peak in investment market

But with interest rates rising, there were already signs that the investment market had started to peak before the US sub-prime market crisis.

The ensuing credit crisis is now exacerbating the downturn, with property information group IPD reporting a five per cent fall in the average capital value of office accommodation over the year to December.

The credit crunch also threatens the demand for office accommodation. The central London office market dominates the sector and the -capital -currently accounts for 40 per cent of new office projects.

The rising demand for office space has in part been driven by a buoyant financial service sector, which has taken on 210,000 people since 2004. Property firm CB Richard Ellis estimates that together, banking, finance and business services account for half of central London office space taken up during the third quarter of 2007.

Accordingly, while supply conditions are tight, the demand for accommodation is likely to be vulnerable during the coming year to retrenchment in the financial services sector.

Due to this, developers have become more cautious. The flow of new office projects has turned down from their mid-2007 peak, although they remain ahead of a year ago.

However, it will take time for the current change in sentiment to impact on sector activity. Near term, the high level of work already on site should be sufficient to lift sector output over the coming year, especially as the high M&E element typically weights the value of work towards the end of a project’s life.

CB Richard Ellis expects some 7.1 million sq ft of central London floorspace to be completed during 2008, an increase of almost two thirds on the already high level achieved last year.

But the sector’s longer term prospects have clearly deteriorated over the last six months.

The flow of new projects being let is set to fall back further during 2008 as developers defer planned schemes and others struggle to secure the necessary funding.

The progress of high profile schemes, such as the Shard of Glass, in pre-letting space and securing funding is likely to provide a bellwether over the coming months for how rapidly sector activity decelerates over the medium term.

Allan Wilen is head of business market intelligence at construction information service Emap Glenigan