London Market Holds Its Breath As Values Drop And Vacancy Rises
New data has emerged highlighting the slowdown in the London real estate market: Values are falling, office vacancy is rising and investors are holding back on deals while they wait to see where prices land after the summer break.
“The speed of the interest rate hike has caught the real estate market by surprise,” BNP Paribas Real Estate UK chief executive Etienne Prongué said. “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.”
The question is, will sentiment improve, or will sellers have to accept a new reality of lower prices?
“Yields are also beginning to soften in light of the challenging financial conditions, particularly for assets lacking in ESG credentials, or [that] are noncompliant against shifting legislation,” Prongué said. “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.”
Data from BNP showed strong overall figures for the first half of 2022 masked a significant weakening in the London investment and occupancy markets between the first and second quarters.
Central London investment reached £4.5B in Q2 — 8% down on the same period the previous year, BNP said. The number of office deal transactions was less than half the 10-year pre-pandemic average, pushing the average lot size to record levels.
Activity in the central London office investment market was dominated by Q1, which accounted for nearly two-thirds of investment at £5.3B, compared with £2.9B during Q2.
As investors absorb substantially higher debt and construction costs, pricing has inevitably started to adjust, and sellers of big-ticket assets are having to either accept price adjustments or pause disposals. BNP’s prime City office yield has moved out from 3.75% to 4% as a result, with pressure to move this out further. That is a 7% drop in average prices, and there's more to go.
London sales that have been paused include the £720M sale of Bank of America’s City of London HQ by Norges Bank Investment Management. On the corporate level, Lone Star has also paused the sale of the £3B Wembley Park BTR scheme.
“As geopolitical tensions remain high and inflation continues to rise, the economic outlook remains challenged,” BNP Head of Research and Insights Vanessa Hale said. “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.”
Looking at total UK transaction volumes, investment levels to the end of June stand at £30B, which is on par with H1 2021. Q2 specifically accounted for £12.1B, a 32% decrease on Q2 2021.
On the plus side, London remains an attractive destination for overseas investors. This is particularly true of Asia-Pacific buyers, recording a 249% growth in acquisition volume in H1 and accounting for about 40% of overall Central London office investment activity so far this year.
In terms of the office leasing market, a number that helps explain the continued weakening of the market is 27.6% — the average office occupancy in the UK for the week ending 15 July, according to data from Remit Consulting.
That compares to an average occupancy of about 60% before the pandemic, and the figure has plateaued, hovering between 25%-30% for the past four weeks. This new normal does not appear to be stimulating demand for new space.
It is a cliché, but the bifurcation of London’s office leasing market, with the best offices doing well and the rest struggling, is now clearly observable in the data.
Prime office rents rose in Q2 in Mayfair & St James (+8.33%), Soho (+5.55%), Oxford Street (+5.55%) and Paddington (+14.28%), and have maintained across City, Victoria and Midtown.
And central London office occupier demand saw the strongest Q2 since 2015, with take-up reaching 3.49M SF.
But on a net basis, central London vacancy stands at 8.9%, up on the long-term average (6.4%) and 0.3 percentage points above the 8.6% recorded at this time last year.