The London office market is enduring the full force of the financial turmoil, given its exposure to the sectors and companies that have been hit hardest by the crisis. Even the resilient West End market has been affected, with rents falling faster than in the City during the first quarter of 2009. The rate of decline showed signs of slowing in the second quarter, yet rents are expected to continue falling this year and next because tenants remain under pressure.
The power has shifted tooccupiers and away from landlords, who arebending over backwards to fill space and keeptenants. For example, Hammerson signed its first letting at 60 Threadneedle Street in the City to Talbot, a Lloyd’s underwriter, for a term of 15 years including a 42-month rent-free period. Nomura has agreed to take a new City headquarters at Watermark Place in a deal that includes a six-year rent-free period.It will take a 20-year lease.
Despite a gloomy outlook for the occupier market in the short term, London has benefited froma miniinvestment boom for prime assets, asoverseas buyers boostedtransaction volumes duringthe second quarter. The office sector has attracted a wave of foreign capital because it has undergonea severe price correction, and the UK is expected to recover earliest from the downturn because it was the first to enter recession.
Furthermore, interest has been driven by a relatively weak pound and the view that yields are now at a high, coupled with historically low interest rates. Euro-denominated vehicles, including German, French and Italian funds, are particularly active.
German pension fund BVK bought Tishman Speyer’s midtown office building, Centrium, in August for £130m (€148m)-a 7.1% yield. The deal came after Tishman turned down a bid of £125m from Spanish bank BBVA in June, and reflects the competitive environment for foreign buyers of primecentral London assets.
However, another Spanish investor, Metrovacesa, last month pulled out of its deal to buy the Walbrook Square office development in the City in order to avoid estimated construction costs of £840m. The company will pay a £100m penalty to withdraw from the scheme.
The fallout from the deal is a reminder to investors that the market remains tricky. Risks surround the perceived stability and yield compression in the market. For example, demand and supply imbalances, not property fundamentals, have driven recent yield levels. Moreover, the value of sterling has appreciated in recent weeks, reducing London’scurrency advantage, while other European cities have corrected further and are posing as potential competitors for foreign investment.
Lack of available stock
This situation could be compounded by a lack of available stock for sale in the future, given that UK REITs have ended their recapitalisation process and are now generally viewed as buyers and not forced sellers. This excludes British Land, which has indicated that all of its assets are for sale at the right price. It isin negotiations to sell its 50% stake in Broadgate, a major City office complex.
Another concern regarding supply is the fact that banks are not foreclosing on property and have yet to release assets onto the market for sale.
Buyers still outweigh sellers and the prime London office sector remains a hotspot for international investment, but this could change if some of the current factors drivingyield compression change, proving that the past few months have been a false start rather than genuine recovery.
