Some of my friends recently asked me about the situation of the London real estate market. Well, there is no simple answer to the question. There are many sub sectors in real estate market, and the market situations constantly change.
We are all aware that higher interest bills and vacancy rates and falling valuations are making refinancing harder and leading to the prospect of forced sales. As a result, many investors are hesitant to participate in the real estate market. Not all submarkets, however, are struggling, and there are some new real estate investment trends that, in my opinion, worth our attention.
I would like to focus on London office market in this piece of writing. I will talk about hotel, retail, and residential real estate markets later in the following posts.
Vacancy Rates
Regardless of the building condition, the central London office vacancy rate has been rising since 2020. This is primarily due to the fact that since the epidemic, more and more people work from home, and more and more businesses opt to downsize their office spaces.
Over the previous ten years, there has been a substantial decrease in the demand for lower-quality buildings. Since more and more businesses are requiring high-quality sustainable buildings to meet ESG criteria, we can anticipate that the trend will continue.
Office Yields
London's office yields have been rapidly rising from 2022 to 2023. As more and more office investors decide to sell their properties in order to stop further losses, office values significantly fall and yields climb. Compared to the rest of London's offices (with a standard deviation of 0.64%), offices in Central London appear to have been more resilient over the previous ten years, with a standard deviation of just 0.33%. That makes perfect sense given that the majority of large corporations have offices in the central London and that they have a higher survival rate than smaller corporations during difficult times, suggesting that most of buildings in central London have more stable leases.
Investment Activity
Investment volumes in the Central London office market experienced a decline in Q2 2023, falling by a third to just over £1.4 billion. Year to date, investment volumes amounted to £3.6 billion, reflecting a significant decrease compared to the £7.7 billion traded during the equivalent period in 2022. The H1 2023 investment volumes were also 41% lower than the 10-year H1 average of £6.0 billion.
Rents
In London, the average rent for Grade A offices is £73 per square foot and £52 for Grade B offices. The highest rent for Grade A offices is in the Mayfair and St. James's area ($110 per square foot in 2021, $120 per square foot in 2022, and $120 per square foot in 2023).
Rents for Grade A workplaces are often more reliable than those for Grade B offices. From 2021 to 2022, the average rent for Grade A offices climbed by 7.76%, but from 2022 to 2023, it declined by 2.77%. The average rent for Grade B offices fell by 6.76% in 2021 and 3.93% in 2022 and 2023, respectively.
One of the factors contributing to the substantial decline in building yields can be seen in the declining trend of rents from 2022 to 2023. The demand in office spaces has been declining due to the work-from-home new normal while the demand in residential property is way less elastic, giving the suppliers more power to increase the rents. Also, unlike residential property owners, who can reset rents annually, office building owners typically have long-term leases with fixed rents with tenants, which prevents the owners raising rents in time to offset rises in inflation and debt yields. Therefore, office building owners have to lower the rental prices of new leases to attract tenants and, in the mean time, the owners are not able to reset the existing leases to limit the loses.
The interesting thing is that, despite the unfavourable outlook for the entire office market, Soho's office rents have been rising from 2021 to 2023 for both Grade A and Grade B offices.
Now we’ve figured out the vacancy rates, yields, investment activities, and rents in this market. These statistics paint an unfavourable picture of the London office market. But does that mean investors should now steer clear of office investment? My answer is not necessarily. If you read my previous article – how to take advantage of crisis, you will probably get the idea of “every crisis brings new opportunities”. In the next section, we are going to look at some recent deals to see how the collapse of office market brought new opportunities.
Recent Deals:
No.1
Canadian pension fund Oxford Properties and life sciences specialist Pioneer Group have launched plans to convert Victoria House (office space) in Bloomsbury Square, central London, into a life sciences hub. The project has secured full planning approval, and Oxford and Pioneer Group have also announced that Victoria House will be the new home of the BioIndustry Association, the trade association for UK life sciences.
Victoria House is a Grade II-listed building, which boasts a neoclassical facade with internal art deco features. Oxford and Pioneer Group plan to convert 220K SF of the building’s 300K SF internal area into wet lab-enabled life sciences space. The project is on track to achieve BREEAM Excellent certification and is targeting an EPC A energy rating.
No.2
WeWork has sold to Hines the 103K SF office building in the Soho district of London’s West End it bought before its aborted 2019 initial public offering attempt. Hines said that the building was bought by its Hines European Value Fund 3 and would be further refurbished to create high-quality workspace with strong environmental, social, and corporate governance credentials. It said the building was vacant, with WeWork having moved out of the flexible office space it previously ran in the building.
No.3
Banking giant HSBC is to move its world headquarters from its 45-storey Canary Wharf tower back to the City of London. The financial business has confirmed that it will move out of 8 Canada Square by 2027 when its lease expires. The move after two decades at the location is part of HSBC’s plans to downsize its office space, as the bank said it is now committed to flexible working. HSBC is negotiating a new lease on British Telecommunications' former headquarters in the Panorama St. Paul's development, which will be much smaller than the bank's current headquarters, which houses about 8,000 staff. The Panorama building is owned by Orion Capital. HSBC said the new development "is being designed to promote wellbeing and constructed to best-in-class sustainability standards, using predominantly repurposed materials."
New Rules:
According to financial times, The City of London is planning to introduce new rules that would make it easier to convert defunct offices to other uses — but is wary of allowing conversion to residential because of the headaches residents can cause for new developments.
But conversions to residential would not necessarily receive more favourable treatment because homeowners can stop new commercial developments that infringe on their homes by blocking light or creating noise. That could impact the City’s viability as a business district. The City already has an exemption from planning laws that allows offices to be converted to residential if the outside of a building is not altered.
These deals show a growing need for flexible, environmentally friendly office space and buildings designed for specific uses, such life sciences and student accommodation. With the new rules, offices can be converted to other specific-used buildings faster and cheaper. Therefore, although the market is alarming right now, we still can see a silver lining. Office renovation and redevelopment to higher ESG-rating office spaces and buildings for other specific uses will get more and more investors’ attention.
Very interesting!