Commercial property gloom is unjustified

City of London

People involved in assessing the value of UK commercial property became very gloomy after the Brexit vote. They often marked valuations sharply lower, by 10% to 15%, only to discover there were plenty of buyers at new levels and no decent stock to sell. They argued there would be less space required, especially in central London, which would put pressure on rents and capital values. After a few months they had to admit values were little changed.

Now, two years on, the opposite has happened. Tenant demand has gone up. Capital values are strong. There is plenty of investment demand for well let buildings. Foreign buyers regularly pay well over the previous pessimistic values local professionals ascribed to buildings.

Just look at the ‘trophy’ sales at the top end of the office market. The Cheesegrater Building, Leadenhall, sold for £1.15bn in March 2017. The Walkie Talkie Building at 20 Fenchurch Street found a buyer at £1.3bn. Recently, 5 Broadgate was snapped up for a competitive £1bn on a yield of 3.95%. That’s three large London skyscrapers finding new owners for more than £1bn each on quite low yields. The buyers have confounded the valuers. In some cases properties have sold substantially above the recent valuation, underlying the undue caution in some of the figures.

The UK has been especially good at attracting the large success stories of the American digital revolution

Further evidence of a healthy market comes from a surge of inward investment into UK property. In 2017 for the year as a whole London was once again the most attractive investment location for people buying commercial property. At £14.2bn London was the clear winner, almost three times the £5.1bn invested in second placed New York.

Examining the mix of tenants renting properties shows how London is changing. Financial sector businesses are taking more space, but they only accounted for 19% of the extra in 2017. 31% of the new space was taken by telecoms and media businesses, with other new technology areas on top of that.

The UK has been especially good at attracting the large success stories of the American digital revolution. Apple is taking 500,000 square feet in Battersea. Facebook has a new 600,000 square foot headquarters in Kings Cross. Nearby, Google is commissioning a large new 1 m square feet space for its Head Office. Bloomberg is taking on 760,000 square feet in Queen Victoria Street in the City. Smaller space is also being gobbled up by high tech start-ups and smaller companies, with a number of flexible space providers able to supply an expanding range of serviced offices which they often favour.

Some of the major UK property companies were also infected by the gloom and scaled back their development programmes. They were sellers of some of the completed investments, wishing to reduce their borrowings in fear of a potential recession. As a result, the London development pipeline after this year and next looks very modest. Today there are plenty of cranes, though many of those are putting up residential rather than office properties. Some 7 million square feet of speculative office space is under construction. This compares with an annual take up of 9 million square feet. The good lettings at large locations like 100 Bishopsgate remind us that there is brisk demand. Pre lets are common, with many floors in build today underpinned by committed future tenants.

Property yields remain generous compared to bonds and shares. There are plenty of global investors who see UK property as a relative safe haven, with a domestic currency that is now looking cheap as a result of the strengthening dollar. There is considerably less new office property being planned for the early years of the next decade in London, so if demand from tenants is sustained at a level anywhere near recent experience there will be a shortage of good new space. The technology boom rolls on, and London now is emerging as a great global centre of technology companies. With the US majors all in London and operating at some scale, there are plenty of opportunities for suppliers, service providers and challengers to grow nearby.

So what are the threats to this generally favourable outlook? If the UK embarks on a series of interest rate rises this will have some impact on property yields. Given the slowdown in the general UK economy that monetary and fiscal tightening have already caused over the last year, this seems an unlikely scenario.

The UK could embark on further policy changes which are hostile to foreign capital investing in UK property. The government has pursued a policy against rich individuals that has hit top end residential properties, and has targeted Russian investors for political reasons. More tax changes or political attacks on footloose foreign capital could damage the market, given the importance of foreign money to its success in recent years. Was the UK to be the first mover in imposing new and higher taxes on digital companies that could put off new arrivals and deter expansion by those already settled in the UK.

The Brexit vote which led to the pessimism has not has a lasting adverse impact on property values, and has not led to an exodus of businesses to the continent as originally feared. As we are now only six months away from official exit, with or without a Withdrawal Agreement, it appears the market has started to revise its unduly negative views. Indeed, critics of Brexit like Deutsche Bank have signed new leases to show a 25-year commitment to a city that is leaving the EU when the UK exits.

 


The above article was previously published by Charles Stanley on 21st August 2018

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