Lack of availability, not demand
While Brexit has continued to hit the UK property market, several underlying trends are starting to paint a different picture, particularly in the central London office market where its expanding skyline is proving more resilient than expected. Research conducted by the Financial Times earlier this year, for instance, showed that London’s top 15 banks have collectively cut fewer than 3,500 jobs in the UK capital since the Referendum. The FT’s report said this is only 5% of the 15 banks’ City headcounts and that fewer than 1,500 of those moves were linked to Brexit. Of course, some individual cases, such as Deutsche Bank’s announcement to slash jobs globally, are unrelated to Brexit or the London market.
Even so, 2019 has seen a dramatic drop in new deals with small and medium-sized businesses in the capital city particularly hard hit. In terms of volumes, Savills recently said that the first half of the year could end up being the slowest since 2011. Indeed, one of the biggest impacts of Brexit has been the reticence to commit to property development – Colliers International recently estimated that overall availability of office space in London is at least 15% below the 10-year average. However, while fewer completions have been coming off the ground, the record-low level of new supply is somewhat surprisingly being met with stable occupier demand as well as sustained investor demand - from long-term investors both home and abroad. This also has resulted in stable pricing rather than the “Brexit discounts” that many had imagined.
Some recent landmark deals do stand out. For example, Citigroup’s acquisition of its EMEA headquarters (HQ) at 25 Canada Square in Canary Wharf earlier this year for £1.2bn marked the fourth consecutive quarter that a London office asset has been sold to a foreign buyer for at least US$500m (£393m). This string of large-scale acquisitions by banks or multinational companies suggests interested global investors are taking a long-term view and, despite the current political uncertainty, believe London still has a robust occupier base and unrivalled talent pool. This is especially true for technology companies which want to have a presence in Europe but also because of European Union (EU) regulation veer towards London.
In addition, we are seeing new foreign investors, not only more from the US, but ironically some from Europe, that are keen to access the unique central London office market and take advantage of foreign exchange opportunities against a depreciating sterling. Slovakian developer JTRE is an interesting example. It recently announced a 10-year plan to grow its presence in London because of the city’s “attractive IRR and vast base of occupiers” stating that it is looking to invest £350m over the next three years. This was soon after acquiring 185 Park Street, SE1, which is the site for its £400m mixed-use development with London-based developer Sons & Co.
In 2018, 79% of all London real estate acquisitions were made by international investors, according to a report by JLL, the global commercial real estate services firm. This includes Apple’s new London campus at the Battersea Power Station, which has received a lot of fanfare for its sizable investment and spectacular building plans overlooking the Thames. All the same, there has been a steady rise in the proportion of domestic investor deals as well this year, some also focused on the regeneration of old landmark sites.
Fundamental market drivers in London’s office space have remained relatively strong in spite of Brexit deadlock and this mainly boils down to the capital city’s diverse base of occupiers and highly professional workforce. The other attraction of London from a real estate point of view is that it is polycentric. There is not just one central business district (CBD) or West End, but instead lots of different sub-markets with their own individual stories and personalities. The same goes for the occupiers in them. The City, for example, has been traditionally known for hosting financial services, but its tenants have become more varied since the Global Financial Crisis in 2008. Given digitalisation and high-quality standards of workspace fit-outs, an increasing number of tech firms and other creative, media-like businesses have been moving into the array of conceptual buildings across the Square Mile. WeWork, the co-working/flex space operator which is now the largest occupier in central London, has attracted more Technology, Media and Telecommunications (TMT) companies, especially within the still-thriving FinTech scene in London.
Stunning plans for the Canada Water Masterplan to regenerate 53 acres in Southwark, South East London serve as a good reminder of how London is also home to many world renowned consultants and architects designing state-of-the-art mixed-use and people-orientated buildings. With tighter supply levels and ever-changing employment trends, large multinational corporations also spend a lot of time and money designing their spaces to make employees excited to come to work and feel like they are part of a “smart” community. A prosperous property development is now more about how the space delivers for the end-users and their experience, so factors such as Environmental, Social and Governance (ESG), well-being and higher tech are paramount. Facebook’s ultra-modern HQ development in Rathbone Square is a prime example of a big state-of-the-art project in central London. The 2.3 acre site was the Royal Mail’s former West End Delivery Office, but the new building (costing Facebook £17.8m a year to rent on a 15-year lease) has a rooftop park and claims to have the largest open floor plan in the world.
Another large development worth mentioning is St James’s Market, the massive mixed-use revitalisation project in old, unused commercial spaces near Piccadilly Circus. Designed by London-based Make Architects, well-known for placemaking and urban design, the development is a joint-venture between the UK Crown Estate and Oxford Properties Group. When recently announcing the second-phase of the project, Chris Carter-Keall, Managing Director and Head of UK Real Estate at Oxford Properties said in a press release that the focus is “to connect people to exceptional places” and added: “Our partnership with The Crown Estate has delivered a transformative development with the completion and letting of phase 1 of St James’s Market. This joint venture is now focused on working together to deliver a truly connected environment that will welcome forward-looking companies that wish to attract and retain the best staff investing in placemaking, sustainability and excellent customer service.”
Along with this is the increasing focus on eco-friendliness and a prime example is Bloomberg’s new European HQ in the City, which is considered by many to be the world’s most sustainable office building. Set between the Bank of England and St. Paul’s Cathedral, it received the highest-ever Building Research Establishment Environmental Assessment Method (BREEAM) score in 2018 after seven long years of planning and construction. The New York-based news and financial tech giant partnered with architect firm Foster+ Partners for the new building, which has a collection system on the roof for recycling water as well as vacuum-drainage toilets (similar to those found on aeroplanes) to help reduce water usage.
Despite the negative impacts of Brexit, industry market surveys and forecasts continue to reflect a more positive long-term view of London office space, pointing out the sound legal structure and business standards too. CBRE’s Global Investor Survey for 2018 revealed that the UK remains one of the most attractive markets in the world for making investment purchases – it ranked number 2 behind the US. (The UK also still has a much higher share of cross-border deals than both the US and Canada.) JLL’s latest Global Transparency Index survey states that London has managed to maintain its reputation as the world’s most transparent real estate market as well.
Diversified investor base
The UK commercial property investment base has long been regarded as highly international and diverse. This is in part due to the nature of the UK economy in general: for example, 70% of the FTSE 100 companies make most of their earnings overseas. Whilst Brexit has taken its toll on the economy, London’s position as an international business and financial centre has not been as tarnished as was anticipated and for long-term investors remains an important slice of diversification in their portfolios.
For example, even though volumes are down from previous years, we continue to see interest coming from Family Offices and high net worth investors (HNWIs) - keen to diversify into real estate more as part of their alternative asset strategies to find uncorrelated investments. Unlike institutional investors, the private wealth sector are not constrained by market-index benchmarks and tend to make more direct, private investments in real estate. Acquisitions of “Trophy” assets in the London office market have still been made; not least for international investors given the cheaper sterling. However, this is not to say that domestic ones do not exist, as witnessed by British family-owned investment firm Charles Street Buildings recently purchasing the Conservative Party’s campaign headquarters from AVIVA Investors for £51.5 million and looking to invest in a City office building to expand their London presence.
Family offices come in all shapes and sizes but because most are so private and prefer not to be publicly named in deals, it is difficult to quantify the amount of capital that is being managed through them. However, The Economist recently estimated this to be around US$3-4 trn. Private wealth deals in the central London office market are often driven by special interest and conviction in certain luxurious properties or districts. A handful of ultra-high net worth family offices from Asia have made acquisitions in London over the past year, including the Singapore family office Pacific Eagle on the £180 million purchase of Belstaff House, a Grade II listed property in New Bond Street. In nearly all cases, the strategy is long-term wealth preservation – and London, for those who can afford it, is not unloved in this regard.
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The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments.
CLI01458 Expiry 30/09/2019