COMMENT The UK office sector is going through its own evolutionary moment. Much like retail property amid the rise of e-commerce, values have fallen rapidly along with the appetite for the sector from investors and lenders.
But as with retail, it is far too simple to say the asset class no longer offers value. The pandemic has certainly had a negative impact on much of the market, but the basis for good offices in strong locations remain compelling.
As a lender, the market trends over the past couple of years have caused us to reevaluate our strategies. After spending much of last year focused on the management of our loan book, we decided to expand our focus to include operational real estate.
That is why we are keen to support lending against offices which offer value-add potential and a strong operating partner. Some of the best-performing offices are now considered operational real estate, and that brings significant opportunities.
What’s hot and what’s not
Offices have been tarnished with one broad brush – particularly by those with a foot in the US who see that market as a sign of things to come. While any investor is right to be cautious, there remain positive signs that suggest the UK market – in the best locations – is weathering the storm well.
Good buildings with small and flexible floorplates, well located, on high streets with strong transport links and appealing amenities nearby, and that are managed by a competent operating company, are the most attractive.
At the same time, some offices are barely worth the land they stand on. The asset class is saturated and there will need to be a rebalancing for the wider sector’s health and, indeed, for the health of town centres in which there are too many offices and not enough amenities.
That is not necessarily a bad thing – it just requires a developer who knows what they are doing, who can navigate the planning system, and has the equity backing or debt partnership to finance it.
Navigating lending against offices – whether for repositioning or repurposing – requires an understanding of the trends shaping real estate. That is one of the reasons that paying close attention to the operator has become a key consideration.
Why flex matters
As flex accommodation gathers more pace, the covenant of the building’s operator will increasingly impact the capital value.
As an industry, we are still getting our heads around the emergence of offices as operational real estate, and it is something that banks in particular are struggling with.
Traditionally, they have needed to see long leases and cashflow for the next 10-15 years, and thus provided debt against buildings with anchor tenants on long leases and good covenants. That long-income profile no longer exists as occupiers’ needs and wants have changed.
Likewise, some banks will look at WeWork and – once again– tarnish an entire industry with one broad brush. The issue with WeWork was that it had an overly ambitious growth strategy that saw it taking on too many buildings in the wrong locations. WeWork’s successors will likely have learned the lessons, focusing on quality over quantity while retaining the flexibility that will enable sustainable growth – both for the operators and their customers.
Fundamentally, the most important consideration is liquidity. If the asset were to go on the market, would there be a buyer for it? Assessing that requires an understanding of who is actively buying – quite often private investors and family offices – what they and occupiers want (particularly when it comes to EPC and other sustainability credentials), and whether the asset will be managed in a way that enables a strategic partnership between owner, operator and financier.
In much the same way that banks historically wouldn’t lend against a hotel unless it had a lease in place with a well-regarded operating brand, so too they will not now lend against offices on the same basis.
That will change – but, like hotels, the office will benefit from the brand not of an anchor tenant but instead one of the many emerging flex office operators. That will increase its capital value and deliver attractive returns to those lenders savvy enough to get in early.
For us, the appeal of the office market isn’t only in the strength and potential of individual assets. It is also attractive because others don’t see its potential and because the sponsors with which we partner are strategic, sophisticated investors. That is why selective repositioning of offices are among the great investment opportunities right now.
Daniel Benton is director at GRE Finance
