London’s offices are facing the biggest market “reset” since the financial crisis.
According to figures from BNP Paribas Real Estate, sales of London offices have dropped sharply and values are being revised lower amid rising interest rates and fears of a recession.
The research shows that a leap in the UK base rate from 0.1% to 1.25% over the past eight months has taken the heat out of a sector that was on track for its busiest start to the year and threatens the value of offices owned by major institutions, such as pension funds.
In all, investors poured £8.1bn into central London offices in the first six months of this year, the highest half-year total since 2007. But the vast majority of that deal flow was in the first quarter. Since then, buyers have retreated or were pushing for discounts to reflect the new, harsher economic environment.
Total H1 central London investment stands at £10.3bn, said the consultancy.
Activity from cross-border investors remains strong, however, with Asia-Pacific investment up by a whopping 249% in H1 and the investor base accounting for around 40% of all central London office activity during the first six months of the year.
BNP PRE UK chief executive Etienne Prongué said: “The speed of the interest rate hike has caught the real estate market by surprise. As it stands, rising debt costs and the deteriorating economic outlook are impacting pricing discussions, causing some sellers to pause disposals and wait for improved sentiment.
“Yields are also beginning to soften in light of the challenging financial conditions, particularly for assets lacking in ESG credentials, or are non-compliant against shifting legislation. The market is now pausing for an adjustment in pricing – when it does, there is still plenty of equity ready to deploy. What remains unclear is how the leasing market will adjust in response to changing market conditions over the next 18-months.”
BNP PRE’s prime City office yield has moved out from 3.75% to 4% during the period, with the expectation that this will move out further.
Despite the softening of yields, BNP PRE’s research also revealed steady growth in rents across several prime London markets. In Mayfair and St James’s rents were up by 8.33% in Q2, in Soho they were up 5.55% and on Oxford Street up 5.55%. The agent said the occupational market remained robust for best-in-class product, but warned that central London vacancy rates were on the rise, standing at 8.9%, which is more than two percentage points above the long-term average of 6.4% and 0.3pp above the 8.6% recorded at H1 2021.
“As geopolitical tensions remain high and inflation continues to rise, the economic outlook remains challenged,” said Vanessa Hale, head of research and insights at BNP PRE. “Consumer confidence has fallen significantly in recent months as concerns around personal finances are exacerbated, meanwhile, businesses and investors are having to absorb rapidly rising finance costs, therefore applying pressure to the real estate market.”
Across the UK as a whole, transaction volumes for H1 stood at £30bn, which is on par with the same period in 2021. Comparing Q2 2022, with Q2 2021, however, reveals a 32% drop of in activity to £12.1bn.
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