United Kingdom May Face
An Office Property Glut

Buildings under construction in the U.K. rose to a 15-year high in the three months to the end of September, according to research by Jones Lang LaSalle, meaning supply could exceed demand in coming years and rents could drop.

The rise in construction came as Londonwide vacancy rates fell to their lowest level since 2000.

"Developers have started building speculatively earlier in the occupational cycle than ever before and next year will be a peak year in terms of speculative supply coming onto the market," said Neil Prime, Jones Lang LaSalle's head of office agency in London. "The demand curve will be behind supply and going into 2009 we may see rents dropping by 5%. If demand isn't back with us by the end of next year, there will be a lot of office space to fill."

Chris Northam, European director responsible for City of London investment at Jones Lang LaSalle, said increased supply could hold back property values as retail funds sell assets to meet redemptions amid the limited availability of debt.

Robert Peto, chairman of the Royal Institution of Chartered Surveyors' valuation facility, warned last month that U.K. property valuations in the three months to September were 10% too high.

Investor demand has been flagging since the summer and fell after data provider Investment Property Databank reported negative total returns from U.K. property in September for the first time since 1992. Retail funds, which have played a significant role in maintaining property prices over the past year, have experienced hundreds of millions of pounds in outflows.

Investors would typically borrow money and step in to maintain demand, but because of the credit crunch there is little financing available, according to Mr. Northam.

Projects have been held back from starting because of a lack of financing, said Alan Carter, head of European real-estate sales at Citigroup Inc. "We are at a tipping point," he said. "There is a lot of supply coming on line next year. Demand could grow but not with the degree of urgency to drive rents higher."

Mr. Northam added, "The credit crunch and future demand are closely related. If the effect of the credit crunch fades, demand will increase. If you are onsite now you will finish development, but not if you are not on the ground."

As a result, supply may be more restricted by 2010 or 2011, with the supply-demand balance again benefiting investors, he said.

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