Interest rates, quality & sustainability
High interest rates are being blamed for a slump in Central London’s office market, in the first 6 months of 2023, with investor spend on buildings dropping by more than 50%. The total investment volumes were 55% lower than a year earlier, and a 42% fall from the ten year average.
Rising borrowing costs add further pressure to a market that is undergoing big change, for a variety of reasons. Hybrid working remains popular, post pandemic, and other factors such as “Best in Class” and sustainability are both having their effect
On borrowing costs, Julian Sandbach, head of central London capital markets at JLL said: “The extent of the slowdown in capital invested in central London commercial real estate in the first half of 2023 is profound. The effects of rising interest rates have had a material impact on pricing and confidence as investors continue to seek higher returns to compensate for the margin required over the risk free rate.
Whilst the level of completed transactions has reduced significantly, there appears to be more of an acceptance by owners as to where pricing has fallen to, despite the lack of transactional evidence for valuers to use, and we do expect to see more activity in the second half of the year, particularly if we see current acute volatility settle and positive messaging around the cost of money peaking.”
Property developers, British Land, identified the gap between the “best and the rest” also beginning to define the London office market. A “flight to quality” across banking, finance, professional and creative services will see returns on the best properties continue to look healthy in spite of the uncertainty due post-pandemic working practice changes.
BL boss, Simon Carter, stated “Ultimately, value in real estate is created over the medium to long term. We like to invest in supply constrained segments with pricing power, where we can be market leaders and leverage our competitive strengths to generate attractive returns. We already lead in campuses, where we continue to see strong demand for best in class space and are increasing our focus on life sciences and innovation sectors. We are consolidating our position as the largest owner and operator of retail parks where scale is an advantage, and we are building a unique portfolio of centrally located and highly sustainable urban logistics schemes in London.”
Meanwhile Jones Lang Lasalle has identified that London’s office space, certified as sustainable, is trading for over 20% more in sale value and 11% higher rent than other offices. These figures agree with research undertaken by Knight Frank (back in September 2021), which then showed that the average impact of BREEAM certifications impacted office rental value.
Julian Sandbach,s at JLL, observed: “This research endorses what we have been witnessing in occupational and investment markets within Central London for some time, namely buildings with strong sustainability credentials will lease for premium rents and sell for premium yields.”
Research shows that the market is attaching higher prices to more sustainable assets, in anticipation of higher returns and lower risks. It also shows that this is resulting in improvements being made to the environmental performance of London’s office stock.
The London office market is dominated by companies in services industries such as banking, asset management and law many of whom have made public commitments to reduce their carbon emissions. As such the property market is feeling the green effect, quality effect and the ever present impact of the changing cost of borrowing. The latter moves with global economies and the former are surely linked to one another. Are not quality office premises more likely to be green and is there such a thing as a poor quality green building?