Four reasons London office values are about to rise

There has been a lot of doom and gloom reported around the second quarter of 2019 investment numbers for London. And understandably so, given there was only £1.5bn of transactions completed, compared with £4.7bn for the same period last year. This is 60% below the long-term average, and the lowest level of investment turnover since 2010.  The Brexit uncertainty is largely to blame, of course, with many overseas investor groups taking a wait-and-see approach, mainly due to currency volatility. However, there are four reasons this market weakness will be short-lived. 1) The London office leasing market is in remarkably rude health from an investor’s perspective.  The anticipated exodus of jobs leaving London has just not happened. If anything, the number of net new jobs added to London’s economy since the EU referendum has risen in the finance, professional services and technology sectors. And it is these sectors from which the bulk of occupier demand is coming.  Some sub-markets are stronger than others, but the vacancy rate across London has fallen to an historic low of 5.5%. Combined with a very restricted speculative supply pipeline over the next three years, the market favours the landlord and tenants are increasingly realising that. Headline office rents are rising, and we are forecasting an acceleration in rental growth across almost all markets over the next five years. Until recently, prime rents in core London had been static for some time. Introducing rental growth will be seductive to many investors that have been focussing elsewhere, and a driver of pricing we have not seen for some time. 2) Overseas investment in London is always about ‘push’ and ‘pull’ factors.  We may be doing a very good job of damaging a few of the UK’s traditional ‘pull’ factors, but many other countries have their share of ‘push’ factors.   There is substantial international capital waiting on the sidelines to invest in London when some political certainty returns. More recently, other global factors are encouraging some investors to renew their focus on London. We have seen a noticeable increase in investor interest from Hong Kong in recent weeks, a source of demand that has been relatively subdued for most of this year. Combined with the weakness of sterling and an overseas market they know better than any other, London is the number one destination for this capital.  3) There are currently only seven assets with a lot size of more than £100m available in London, compared with close to 50 assets of that size trading in 2018. The ratio of under offer assets to available has risen by a third in 12 months. There is no vendor pressure to sell, and as demand weakened earlier in the year, very little new investment stock has come to market. Consequently, the pick-up in overseas investor demand is now faced with very limited quality buying opportunities. The market can react with more supply quickly, but only when pricing strengthens again. 4) Brexit uncertainty has meant a lot of investor attention has shifted to Europe.  Borrowing costs are lower of course, but cap rates in most of the key target cities are now materially below London, and many do not have the landlord-favourable lease terms that the UK offers. With a return of political certainty, this yield gap will close.  London office values are undoubtedly set to rise. Local politics have held back pricing for too long, and now rising rents and a glaring international cap rate arbitrage are building up a pressure that will be released as soon even a small element of political certainty returns. Nick Braybrook is head of London capital markets at Knight Frank