The global pandemic has weighed heavily on the real estate investment markets in 2020. According to JLL, travel restrictions resulted in greater domestic and inter-regional rather than cross-border investment over 2021, focusing on ‘desirable long-let, core type investments. This ‘flight to safety’ trend is a shift from ‘a global market hungry for yield and deep demand for value-added opportunities in prior years.
In this webinar, David Hourihan (MSc RE Programme Leader at UCEM) and Freya Morrow (Associate Valuation Surveyor, Matthews Goodman) reviewed how the office investment markets in London have performed over the last 12-18 months. The webinar covered the office investment sector in each city under the following points: 1) A Review of the size and structure of the office investment market 2) Key characteristics of the office investments sector 3) Important lease clauses and structures 4) Current market indicators and trends.
UK Office Investment—Size
The total ‘invested’ commercial property stock (held by investors) is £512 billion. In the UK, it is the unlisted investors who remain the leading players. This is followed by listed companies and then overseas investors. There has been an increase in more institutional and international investors coming into the UK market, in what has been described as a ‘flight to quality.’ These investors are focused on core-type investments. Unsurprisingly, London, as a capital, is the main market for office investment. The two primary sub-London markets are The City and the West End.
UK Office Investment —Structure: London and its sub-markets
As David explains, the West End is traditionally a finance district. Moreover, it tends to have the highest rents and lowest yields. The yields traditionally float around 3.5% to 4.5%. The floor plates are generally smaller because of the type of offices and their location. Landmark buildings also characterize the West End. This makes them prime location for front-office, client-facing businesses. Moving across into Midtown, value begins to drop off slightly. Rents hover between £40-£60 per square foot. Conversely, in the West End, it is £100 and above.
Midtown offers slightly bigger office plates and excellent connectivity between the two markets, the West End and The City. It will also be connected by cross rail this year. Next is The City, which is the main financial district for London. Occupiers include the major banks and insurance firms. Rental values are similar to Midtown in the range of £40 to £60 per square foot, and yields are slightly higher, with a range of 4.5% to 5%. The Docklands encapsulates the area known as Canary Wharf, a business financial district. Canary Wharf was created to provide more affordable office accommodation. The rents are thus lower, are ranging between £35 to £45 per square foot.
Research by Savills illustrates that prime rents in the West End have held up surprisingly well over the last four quarters. Freya argues that is a sign that demand is returning to the West End. However, it is precisely Grade A (high-quality space) accommodation that Freya believes will see increased demand.
Beginning with the strengths, the UK is a very mature, transparent market. The UK has recently been ranked as number 1 out of 99 countries on the global real estate transparency index report. Moreover, the economy is showing positive GDP growth, and lockdown restrictions are currently being lifted.
Regarding weaknesses, David points toward market practices, including non-standardization of DCF appraisal techniques and reluctance to adopt more sophisticated quantitative modelling applications. As David contends, there is a lack of consistency in the way investors carry out discounted cash flow appraisals on property in the UK market. For example, David believes the measures of risk need to be better developed and standardized. For example, David believes the measures of risk need to be better refined and standardized.
Major threats are the coronavirus, the difficult trading environment for tenants, and the widening gap between primary and secondary stock. Nonetheless, there are opportunities, including changing work patterns and the repurposing of older office buildings.
London Office Investment Market—Key trends and forecasts
To conclude, Freya and David discussed the key trends and forecasts of the UK Office market.
Freya explains that her firm has incorporated market uncertainty clauses into all of its valuations, owing to their limited knowledge of the conditions surrounding their valuations last year.
Additionally, Freya discussed how investor appetite is currently concentrated on core and core-plus accommodation. Due to the uncertain environment, core and core-plus are perceived to offer more steady returns. She notes that as the year has progressed, activity and demand for speculative office space have decreased.
Furthermore, Freya expects that higher-quality office space rents will remain stable over the next 12 months. Finally, Freya provided some fascinating insight on tenant-activated break clauses. Freya notes that her organization initially encountered multiple tenant-activated break clauses in 2020. However, many of those tenants soon discovered they require office space once again this year. Thus, while tenants may be exercising their break clauses, this does not necessarily mean they are departing the market entirely.