Last week I found myself speaking to two well-respected REIT managers with totally contrary views about the state of the office market in London, writes John Mulqueen, head of transactions EMEA, CBRE Global Investors.
This is not surprising given the uncertain political and economic outlook, but it struck me that their perspective, while rationally explained, also reflected the current constitution of their own portfolios.
It reminded me of a joke in which a man stops and asks for directions to the beach, only to be told: “Ah, that’s a lovely spot but you don’t want to start from here.”
The first manager pointed to weaker occupational demand and signs of distress in capital markets.
He referred to softer leasing terms being offered to prospective tenants across all submarkets, with rental values in some areas falling by as much as 15%, and quoted examples of failed investment sales available at a 15% discount to the original quoting price, suggesting we are on the cusp of a major correction.
The other argued that London will continue to be one of the key beneficiaries of the unrelenting force of globalisation and urbanisation.
This outlook has maintained values to date, as evidenced by recent high-profile deals.
He proposed that now is as good a time as any to buy into London’s long-term future – the weight of overseas capital, particularly from Asia but also from other parts of the world, is a testament to London’s resilience and proof that investors recognise the potential of the UK outside of the European Union.
I agree with both.
We are witnessing markedly different attitudes to risk at both ends of the spectrum and this is affecting pricing, with a widening gap between core and value-add product in the capital which is not apparent in other gateway cities in continental Europe.
In past cycles, investors would have viewed current levels of grade A availability and a low-yield environment as a strong incentive to build.
Investors are, however, understandably cautious about near-term leasing risk in London, and office buildings can be an expensive and high-profile mistake.
Deloitte’s recent Crane Survey suggests that, despite 44% of space under construction being prelet, new starts have receded for the past two quarters, so we are unlikely to see the development pipeline increase significantly any time soon.
Assets offering long-term secure income, on the other hand, continue to attract prices in historically uncharted territory. International investors are willing to accept lower returns for core product, which speaks to their view of risk and future expectations for London.
For cross-border investors there is also an increasingly strong argument for the UK from a relative value perspective.
Since the Brexit decision UK values have remained robust, but the value of continental European assets have increased significantly.
This, coupled with the devaluation of sterling against the Chinese yuan, South Korean won, Malaysian ringgit and Japanese yen means that from an Asian perspective the UK has been heavily discounted.
For an Asian investor, taking account of currency movements and asset values together, Berlin is currently 70% more expensive than it was in Q4 2015 and London is around 15% cheaper on a capital value per sq ft basis.
Near-term risk is currently being repriced in London. I am convinced that the next 12 months will present opportunities to buy from “motivated sellers” offering deals with substantial returns for investors who have the necessary skill and capital to undertake value-add activities.
Core buyers waiting on the sidelines for prices to fall may be disappointed. London remains the most liquid market in Europe and interesting deals find a home quickly. The post-Brexit sale only lasted two weeks for good reason.
