Sun. Nov 28th, 2021

Earlier this month, UBS invited guests to its London offices to discuss the fate of real estate following the pandemic. Despite the Swiss bank’s promise of a free breakfast, most participants preferred it call in from home.

“I’m worried that this is the new normal: people can go into the office, but most choose to go in less than they said they would,” said Zachary Gauge, head of the bank’s European property strategy and research. the event’s host. “If this is the new normal, there is fundamentally too much office space in this country.”

Owners of British offices, especially in London, were in a outward exciting mood since easing pandemic restrictions over the summer and gradually driving workers back to their desks. Prospective buyers have started circling again – seemingly willing to pay pre-pandemic prices.

Investors with more than £ 40bn to spend are looking at opportunities in London, according to real estate agent CBRE. But this interest is focused on the thin top layer of the market – so-called “prime” offices that are modern and environmentally sustainable.

In addition to real estate agents’ bullish forecasts and a slew of high-profile transactions, there are worrying signs. Prime offices make up only 10 to 15 per cent of the total UK market. Owners of “secondary” buildings face real challenges in attracting tenants and the prospect of deep valuation declines as a result.

The numbers of workers returning to offices came to a standstill after it was initially sharpened after restrictions were lifted. UK-wide, average occupancy was just 21 per cent in the week to November 5, little change from a month earlier, according to Lorna Landells at real estate data specialist Remit Consulting. This indicates a reluctance of a significant percentage of the workforce to return to the office on a full-time basis, ‘she said.

This is a serious problem for office owners, but on the face of it, there are few signs of trouble. Most office tenants managed to survive the pandemic. The state-funded pandemic support helped them continue to pay rent, which allowed landlords – usually much less utilized than before the 2008 financial crisis – to pay off their debts.

Line graph of% of staff working at the office (national average) showing The return to UK offices has stalled since the end of October

In recent transactions, investors have shown a willingness to pay top prices for modern offices, especially in London. When the Vatican Knightsbridge office which went on sale earlier this year attracted more than 10 bidders.

The deal is in its closing stages and according to one person close to the discussions, the buyer will pay almost £ 200 million, more than 10 percent above the asking price. “It says something about the weight of capital that London is targeting. It’s hard to get in, there is not a large amount of [suitable] investment market share, so you see a very strong bid list, ”he said.

This mismatch boosted valuations and pushed down returns. In London, yields are now at 3.75 per cent in the City and 3.25 per cent in the West End, down from 4 per cent and 3.75 per cent a year ago respectively, according to Savills.

“As a London salesman, I have to tread carefully. I think [the high demand] is more about the weight of money. . . not because London in itself has particularly fantastic properties at the moment, ”says Stephen Down, head of central London investment at Savills.

Private equity investors have become increasingly active in the London office market over the past few years. Buyout groups set up record levels of subordinated capital and fight it for suitable targets, with property looking more attractive than many other asset classes.

Compared to “highly volatile and top-tier stock market and a compressed bond market, real estate looks more attractive than a proxy bond or proxy stock. London, as a mature market with high liquidity, benefits by default,” he said. Down said.

Gauge said investors should consider two other factors besides the unresolved question of whether there will be a sustained return to the workplace.

Costs for building owners will rise as tenants demand more to appeal to returning workers and returning environmental legislation will require commercial property to meet strict energy efficiency standards by 2030.

Nick Sanderson, chief financial officer at GPE, a luxury office developer in London who wants to buy and refurbish older stock, predicted that tightening energy efficiency regulations “will start to find its way to valuations … we don’t see much yet, but it can come faster than people think, ”he said.

The prospect of impending interest rate hikes, which would mean the end of more than a decade of loose monetary policy, was another matter. “Property in Europe is on a 10-year run. Anything but retail that you could hold, gave a lick of paint and could make a decent return for your investors. . . it led to complacency, ”Gauge said.

Last week, British Land and Landsec, two of the UK’s largest listed landlords, said it would cost more than £ 100 million each to comply with the new environmental regulations. Both have relatively modern, well-kept offices.

For the rest of the London market, “greening costs” will be much higher, says Mike Prew, an analyst at Jefferies. The same will apply to many offices outside the capital.

Line graph of vacancy rate in London offices (%) showing that London offices are empty during the pandemic

Owners of older buildings face these extra costs at the same time as vacancy rates are rising. According to real estate agent Knight Frank, London’s vacancy rate rose from 5.7 per cent immediately before the pandemic to 7.7 per cent, with older offices being hit the hardest.

Office occupiers meanwhile dumped millions of square feet of space on the sub-rental market during the pandemic, most of which is still dwindling, with little demand even for discount space.

The sluggishness in this part of the market can lull investors into a false sense of security. “When nothing happens, it’s seen as a sign of stability, but it should be a concern,” Gauge said. “There is no one to buy.”

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