Analysts at investment bank Jefferies have said offices are set to be the next real estate casualty and have downgraded the stock of Landsec, British Land, Derwent London and GPE.
The firm has now pegged Landsec and British Land as “underperform” down from “hold”, and Derwent and GPE as “hold”, down from “buy”.
“Retail was technology’s first casualty and we think offices are next,” analyst Mike Prew said in a note. “Utilisation has shrunk and landlords are losing pricing power as tenants offload surplus space. London vacancies are at a 30-year high and above the tipping point at which rents fall except for scarce green-ium rented towers.”
Jefferies said vacancies in the West End stand at 7%, in the City at 10% and in Canary Wharf at an estimate of more than 20%, adding: “The tipping point for a rental recession is historically [about] 8%.”
“We estimate a 20% contraction in London office utilisation on WFH and hybrid working, with reoccupation focused on core green HQ buildings and SMEs in the suburbs,” Prew wrote. “Flex, co-working and serviced offices operate [account for] 9% of London space and have absorbed vacancies and extended this rent cycle. Now the hotel economics of short income/long liabilities mismatch appear to leave landlords with scant recourse.”
The team said office values had absorbed a 100bps cap rate repricing in the past 12 months, with a secondary increase expected following the Bank of England’s June 50bps rate hike.
“Investment market liquidity is receding on rent uncertainty and squeezing developer profits,” Prew said. “The West End is a small-lot-size, equity-driven market with the City leveraged and becoming less fundable with increased uncertainty over tenants renewing their leases. The risk of capital instability increases eastwards from Holborn Circus, with bid-offer spreads gapping out and an increasing overhang of unsold offices being marketed.”
Prew added that Jefferies is modelling this cycle on the “early noughties”, when negative net absorption followed the bursting of the TMT bubble. “Tech tenants became accidental landlords offloading surplus space on the ‘grey’ market to recover costs and under-cutting landlords,” he said. “The TMT index peaked in 2000 with rents -15% two years later and Covid is now having the same effect on offices.”
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