Signs that commercial property remains out of favour with investors are plain to see. The S&P Global Reit Index, a gauge of real estate investment trusts in developed and developing economies, is down about 33 per cent since the beginning of 2022. Global commercial property transaction volumes in the first three-quarters of this year plunged to their lowest level in more than a decade, according to JLL data.
The sharp deterioration in sentiment stems from a confluence of strong headwinds. The two blowing the hardest are the lingering effects of the Covid-19 pandemic and the dramatic rise in interest rates. While the accelerated shift to remote working has crimped demand for office space and put the quality and sustainability of buildings under scrutiny, the surge in the cost of debt has struck valuations and driven up landlords’ expenses.
Commercial property, in particular offices, has become a dirty word in financial markets. In Bank of America’s October global fund manager survey, respondents deemed commercial real estate in the US and Europe to be the most likely source of a systemic credit event.
The UK has been hit hard by the double whammy of the pandemic and rising rates. According to the findings of a survey by Morgan Stanley of office markets in the UK, US, Germany and France published last week, Britain experienced the sharpest rise in remote working since the pandemic began. Office workers are working from home an average of 2 days a week, compared with 1.7 in the US.
In London, one of the world’s biggest office markets, leasing volumes in the first three-quarters of this year were 21 per cent below the equivalent period in 2022 and 15 per cent below the average for the first three-quarters during the past 10 years, according to JLL data. The vacancy rate, moreover, has shot up from 4 per cent at the end of 2019 to 9.6 per cent.
Commercial office buildings in London on October 25. UK office workers are working from home an average of 2 days a week, compared with 1.7 in the US. Photo: Bloomberg
The investment market has shrivelled. In the UK as a whole, offices have accounted for just a quarter of investment activity this year, down from more than half a decade ago, according to CBRE data. Even so, while demand has taken a hard knock, Asian investors have spotted opportunities to acquire assets at a critical moment for London’s office occupier and investment markets.
A combination of factors is luring Asian capital. These include: a “ flight to quality” as best-in-class, amenity-rich buildings with strong sustainability credentials achieve markedly higher capital values and rents; lower financing costs in Asian markets; London’s relatively attractive rental yields; and the transparency and liquidity of the UK market. “It is an attractive point in the property cycle to be deploying capital in London,” said Ed Bradley, head of Central London office investment at CBRE.
A bifurcation, even trifurcation, of the city’s office market has taken hold as the divide between secondary, prime and “ultra-prime” assets widens. The premium placed on high-quality space – not just in terms of location but also building specification and energy efficiency – is a key driver of Asian investment in London.
Moreover, there has been a sharper repricing of office properties in the UK than in other markets, notably in Asia. According to BNP Paribas Real Estate, London suffered the second-steepest fall in office capital values among the main European markets during the past year, behind only Amsterdam.
The resilience and outperformance of high-quality office buildings and comparatively higher yields were instrumental in Hong Kong private developer Chinachem Group’s decision in September 2022 to get into prime London office property. It paid £158.5 million (US$193.9 million) to buy the Kaleidoscope, a newly completed office building in the City of London occupied by popular short video app TikTok.
Four months later, Chinachem bought another prime office building in the City for £349.5 million to bolster its presence in London – the headquarters of Deloitte, which at the time of completion in 2016 was the world’s first office building to achieve top sustainability and health and wellness ratings.
Donald Choi, Chinachem’s executive director and chief executive, said the acquisitions were not so much “a contrarian bet” as an opportunity to invest in “future-proof” office buildings “at an opportune moment to capture the limited window of yield expansion”.
Singaporean and Japanese buyers have also been active in London. The lower cost of debt in Asia – particularly in Japan, where interest rates have yet to rise – give investors from the region an edge. According to MSCI, Japanese buyers were the only major source of capital, deploying more money into offices overseas this year compared with their historical average levels of investment in the sector in the first three-quarters of a year.
Office buildings are pictured across the River Thames in the City of London on November 10. Britain’s economy stagnated in the third quarter, official data showed, weighed down by elevated inflation and interest rate increases. Photo: AFP
Another key factor underpinning Asian investment in London is the UK capital’s role as a safe haven. Despite persistent concerns over the economic consequences of Brexit, London’s unique attractions as a leading global financial hub remain.
The maturity, liquidity and transparency of the UK commercial property market are crucial strengths that have helped the London market reprice more efficiently. “The clarity over pricing is like nowhere else in the world,” said Julian Sandbach, head of Central London office markets at JLL.
While the price correction in London is entering its final stage and competition from domestic and other foreign investors will intensify when central banks start to loosen policy, the enduring weight of Asian capital is a vote of confidence in the London office market. Although a dirty word for some, offices retain their appeal even in the most vulnerable markets.
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