We recently launched our 'Positioning cities for inclusive growth' report and one of the findings was that investment opportunities will remain concentrated in cities. In this article we look at the strength of the London market and the real estate investment opportunities emerging as the city reopens.
The rush hour commute, typified by the feeling of being crushed on a crowded London Underground train, has become a distant memory for many of London's commuters. Who could have imagined the London we have seen over the last year, the most iconic landmarks and streets normally brimming with workers, residents and tourists transformed into a barren and deserted landscape?
This trend has certainly been more noticeable in London compared to other major cities in the UK and Europe, where office workers with less dependence on public transport and less heavily populated spaces, have been able to return to the office quicker. However, the future is looking brighter for London as strong progress in the vaccination roll-out has put the UK several months ahead of the rest of Europe in terms of the easing of restrictions.
The most recent Government Covid-19 roadmap indicates that London will see a steady stream of office workers returning throughout spring 2021, as restrictions are lifted by the end of June. If the UK remains on track, the second half of the year is likely to see travel restrictions, which have had a chilling effect on international investor site visits as well as tourists, being relaxed. The reopening of London will undoubtedly create opportunities for investors seeking to deploy capital, but to do so successfully is not without its challenges.
Office space
Occupier and employee expectation: Most forward thinking companies have spent time this year surveying staff on their experiences working from home and their intentions for the return to the office. Younger office workers, whose flats and houses are typically less well suited to home working, are particularly keen to return to the office. Many employers and commentators are reporting that a clear majority of office workers wish to have a mix between time spent working from home and spending 2 or 3 days per week in the office. For most companies there is unlikely to be a return to the majority of staff being in the office five days a week.
A better work-life balance may well be the immediate focus and whilst there has been a real drive over the last year or so in encouraging this, the message that we are now hearing in the market is a desire for a return to some semblance of working normality. The draw of the office, the need for positive human interaction and the lure of the city remains. Certainly the working week will look different, as above, but it is now widely acknowledged that there are significant benefits to office life (staff development and training, business interaction, people skills) that need to be factored into the overall strategy. All of which leads us to believe that the office market is well positioned for a strong upturn in the second half of 2021, and beyond.
Opportunity: The trends for offices we are expecting to see in H2 2021 are office redesigns, lower density and greater employee engagement in fit-out plans, with a surge in demand as 2021 progresses and as some occupiers look to increase footprints instead of consolidating. Additionally, co-working spaces in the commuter belt could be an attractive prospect for savvy investors, as employers align their work spaces with employees' needs to reduce their commutes. High grade office spaces will be in huge demand as businesses recognise that top quality office space is a tool which can be used to attract and retain talent. Older office stock in London (pre-2000) will require significant capex spending or will risk becoming worthless, particularly with the drive for ESG (particularly the E). That in turn may lead to opportunities for investors who are prepared to take on development risk.
Availability of stock: The main challenge for investors into London will be the shortage of high quality offices to acquire. Although there are several high profile development schemes ongoing in London, such as the tower at 8 Bishopsgate, demand is likely to outstrip supply for some time to come. According to Bassam Kameskhi, Head of Middle East at Cordatus Real Estate "the main issue for our Middle Eastern and Far Eastern investor clients has been the shortage of high quality assets coming to market." It seems that this problem is not unique to London, as Bassam also commented "'other European markets have even less stock available, so most of the quality options there are available for clients, are in the UK. We therefore see an opportunity in investing into the Office space more than ever. Our house view is that we will see some serious value-add plays by investors turning around traditional office blocks into modern stock, in order to keep up with current market requirements. This includes any of a change of floor layout, ESG upgrades and enhancing the general quality of buildings. Furthermore, we believe London offices will be in favour over other European capitals, certainly in the short term, given the delays in vaccine roll out in mainland Europe versus the UK leading to a slower return to working space."
Other asset classes
Notwithstanding the above inward investment to the UK proved to be fairly robust during 2020, under the circumstances, with London again being the most prominent City globally for inbound activity. This trend has shown encouraging signs of growing so far this year with sheds and beds remaining a particularly attractive asset class for medium to long term investment. Healthcare and Senior Living also remains a popular investment sector which was growing even before the pandemic, and looks likely to continue on that upward trend.
Retail: In the retail sector, severely impacted by the pandemic scale-back on bricks and mortar spaces, where many businesses have had no option but to wind up operations, a significant number of premises will enter the market. We anticipate that this will be evident both in central London and also replicated in major cities across the UK, as national retail chains are impacted. Looking forward, in terms of incoming tenants it is likely that landlords will see requests for shorter-term leases, or turnover leases, as businesses 'test the waters' in the post-lockdown market and mitigate the risk of making a long-term commitment. This will add to the challenges for overseas investors who typically like long-income deals with 'institutional' leases which require a less active asset management role.
There are, however, moves from the UK Government to liberalise planning restrictions, allowing easier change of use on the high street from retail to residential, for example. We foresee some investors being keen to pick up on this new opportunity.
Alternatives: For other asset classes which have been hard hit by the pandemic, such as hotels and student accommodation, we anticipate that, once the Government moratorium on issuing statutory demands and winding-up petitions ends, a number of assets in Greater London will be put on the market as a result of being over-leveraged. Whether the pricing will in any way reflect a 'distressed' nature we will have to see. Indications so far show that pricing across most asset classes is being underpinned by a large wall of capital available worldwide for deployment into assets (including real estate), and that is one significant difference between this pandemic crisis and the Global Financial Crisis of 2008-9 (the GFC). Another significant difference from the GFC is the availability of debt financing this time around, there is no credit crunch per se, although lenders are of course being cautious on the particular assets they will lend against, and the covenant strength of tenants is ever more important.
We expect to see a number of distressed assets, across all sectors, coming to the market in the short-term, as a result of Government support schemes being wound-back and the debt on over-leveraged assets ultimately becoming impossible to service.
The strength of the London market
The reopening of London for investment may happily coincide with a much needed period of relative stability on the political landscape. Although the full implications of Brexit are still being uncovered, the London investment market will remain attractive to international investors particularly whilst Sterling remains relatively weak.
London's real estate market is often compared to Paris, Frankfurt and Amsterdam as rival investment destinations - however London's established position as a 'first choice' for many investors, the decreased pool of investment opportunities across Europe and many European countries entering into further lockdowns, are all factors which could give London an advantage over its competitors.
Conclusion
The reopening of London as a result of the success of the vaccination programme combined with a limited development pipeline, an increase in the availability of distressed assets and demand outstripping supply for quality assets is likely to result in a busy market in H2 2021, and throughout 2022 and beyond, with the advantage going to buyers who have ready capital, can move quickly and can look to re-finance with debt or syndicate their investment at a later date. As London returns to pre-pandemic business operations and UK borders are re-opened with clearer passporting regimes for the 'new normal' we are highly confident that the City's real estate market will go from strength to strength, and that Gulf investors will be at the forefront of this reinvigorated commercial activity.
