Things are getting tougher for owners of London office blocks, but that probably won’t end the trend of energy-efficient refurbishments.
Despite healthy demand from tenants, office buildings owned by British Land, Landsec and
—three of Britain’s largest real-estate investment trusts—lost around 3% of their estimated value over the six months through September, according to results posted last week. In London’s financial district, prices were down almost a 10th.
Further falls may be on the way as interest rates rise. At roughly 4%, the U.K.’s five-year swap rate, a proxy for real-estate borrowing costs, has more than tripled this year. When the owners of London’s best-located offices come to refinance their borrowings, the all-in cost of debt will likely be 6.25%, according to GPE. As that rate is higher than the rental yields these properties generate at current valuations, it will be hard to shift buildings without cutting prices further. This could be a headache for the U.K. property funds of asset managers such as Schroders and BlackRock that need to sell assets to raise cash for investor redemptions.
Demand for space in offices is linked to economic growth, so slowing U.K. output is a bad sign. The tech sector, which has been responsible for 20% of London office-leasing activity over the past decade, is shedding jobs globally. And remote work is sticking: Britain’s offices are being used half as much as before the pandemic. The vacancy rate in central London is now 8.1%, according to real-estate company
almost double its late-2019 level.
This downturn won’t be a rerun of the global financial crisis in 2008, however. London’s listed landlords have much stronger balance sheets than back then, and a modest haven is emerging: Energy-efficient offices are in high demand as corporate tenants try to meet net-zero targets.
REITs are more likely to own this type of building than private investors, which may explain why their leasing teams are busier than the wider market. Around 40% of London office REITs’ properties are rated either A or B for energy efficiency, compared with 15% of the city’s offices overall, based on data from real-estate research firm Green Street.
There will be a shortage of this kind of workplace until at least the middle of the decade. Only 2.5 million square feet of new space a year will be built between now and 2025, compared with estimated annual demand of 4.8 million square feet. Those energy-efficient buildings currently under construction with a year until completion are 75% pre-let, which is a record and should help to push up rents.
Landlords want to take advantage by refurbishing the older offices in their portfolios. It won’t be cheap, with inflation in U.K. construction costs expected to be around 10% this year and up to 5% in 2023. Although this is lower than the 14.1% rate in the U.S., high energy prices in Europe could make building costly for several years.
Still, the unappealing alternative is to do nothing and watch valuations fall further. GPE said the value of London’s less energy-efficient buildings fell 4.2% in the six months through September, while more sustainable ones were down a more modest 2.5%. Going green probably still makes more financial sense for the city’s better-capitalized landlords than letting their portfolios slip into obsolescence.
Write to Carol Ryan at carol.ryan@wsj.com
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