UK investors get creative amid uncertainty in London's office market
As the balance between domestic and international investors shifts in the UK's capital, active players in the market are increasingly focusing on refurbishing existing buildings.
Domestic investors are becoming more dominant and creative in London’s office markets as political uncertainty and a lack of big-ticket opportunities weigh on international investment.
A total GBP 4.5 billion (USD 5.4 billion) was invested in London offices during the first half of 2019, the lowest volume since 2009, according to JLL. Overseas investors spent around 66 percent of this figure, a significant drop from recent years.
The absence of foreign demand has opened the door for UK investors, which emerged as the largest single source of capital over the same period, according to JLL.
UK investors are operating in “a less crowded market for the first time this cycle,” and are happy to do deals around assets international peers can deem too small, says Julian Sandbach, head of central London Capital Markets at JLL.
“Being domestic means being in a good historical position to ride out the current uncertainty and take a longer-term view,” Sandbach says. “Certainly, among those at the top of REIT management, for example, there’s a seniority that calms matters.”
With prime yields sitting at around the 3.5 percent and 4 percent levels in the West End and City, respectively, investor activity has been increasingly focused on assets with expiring leases, presenting investors with an opportunity to refurbish existing properties, he says.
In the City of London, refurbishments account for a rising share of development activity and represented half of development-starts in the second quarter. Their average share in development activity over the past 18 month is 47 percent, almost double the average between 2013 and 2017.
“There’s serious competition among domestic investors for development and refurbishment openings across both small and large lot sizes,” says Sandbach. “But equally, it’s something investors are looking to do to their own assets as a way to improve value.”
Refurbishment is a strategy that UK REITs such as Derwent London and Great Portland Estates are particularly skilled at, he adds.
“REITs have proved to be successful, but they’re also being joined by a raft of other domestic development managers, backed by private funds and private wealth.”
Deals such as Orion Capital’s recent GBP 209.6 million purchase of a London office, owned and occupied by British Telecom with around 30 months remaining on the lease, could be a sign of things to come in a market where vacancy is as low as 0.5 percent for new buildings.
Limited supply in a time of uncertainty
London’s low office vacancy – itself partly due to a slowdown in development of new schemes since the UK’s referendum vote in 2016 – is making investors think “more creatively,” says Sandbach.
“The referendum certainly slowed down development plans and now we’re beginning to see the impact that is having on supply across the city.”
But that’s not the only reason for rising interest in refurbishment. Sandbach says investors with their eyes on London are faced with a lack of choice in the market, as well as a dislocation between bid and asking price.
“International investors are holding off; the uncertainty hasn’t helped,” he says. Instead, they’re increasingly looking beyond London to markets in Europe with Paris the largest recipient of cross-border capital in the first six months of the year, according to data from JLL.
“Yet that doesn’t mean that London as a major office occupational market has lost any of its underlying credentials,” Sandbach adds.
The volume of office space let in the first half of this year was only 7 percent below the city’s 10-year H1 average. More deals which exploit the opportunity for refurbishment and the prospect of a consequent rental lift are likely, he says.
“Such a strategy may not be for everyone, but it underlines the strength of belief in London over the medium and long term.”