In a report where they downgraded Land Securities (LAND.L), British Land (BLND.L), Derwent London (DLN.L), and Great Portland Estates (GPEG.L), Jefferies projected a 20% reduction in the utilization of London office spaces due to the shift towards post-pandemic hybrid working and tenants' increasing preference for environmentally-friendly buildings in suburban areas. The analysts noted that just as technology had a significant impact on retail, the office sector is now experiencing similar challenges. Office utilization has decreased, and landlords are facing weakened pricing power as tenants seek to shed surplus office space.
In response to this news, the stock prices of these four developers declined during early trading on Wednesday. Great Portland Estates saw a 3% drop, while Land Securities, British Land, and Derwent London experienced declines of 1-2%. In contrast, the broader FTSE 350 index remained relatively stable.
As of the time of this report, the mentioned companies had not provided any immediate comments. Globally, property companies are grappling with the dual challenges of declining office occupancy rates and significantly higher financing costs due to rising interest rates.
Real estate firms in various European countries, including Sweden and Germany, have also felt the strain. Moreover, shares of major UK landlords have fallen this year, approaching lows last seen following the UK's turbulent "mini-budget" last autumn.
Jefferies' analysis estimated that vacancy rates in London were at 7% in the West End, 10% in the City, and over 20% in Canary Wharf. Historically, a rental recession, marked by falling rents, tends to occur when vacancy rates reach around 8%. Interestingly, Jefferies pointed out that warehouse landlord Segro (SGRO.L) was achieving rents of over £30 per square foot at the logistics park Park Royal, which were likely higher than the prevailing market rates in Canary Wharf, a prominent location for financial tenants like Barclays (BARC.L), JPMorgan (JPM.N), and Morgan Stanley (MS.N).
In recent news, long-time Canary Wharf resident HSBC (HSBA.L) had announced plans to relocate to a considerably smaller office in the City.
Land Securities, which was hosting a capital markets event for investors on Wednesday, stated that demand for its central London office portfolio remained "strong," with an occupancy rate of 96.9% over the first five months of the financial year. The company had recently sold off £2.2 billion worth of primarily mature offices, typically leased to single tenants. Chief Executive Mark Allan characterized these disposals as "very timely," demonstrating their strategic approach in adapting to a prolonged period of higher interest rates. Allan added that they had positioned the business accordingly over the past year.
Investor confidence in the broader UK real estate sector has been waning, with significant outflows from property funds observed in August, according to the latest Fund Flow Index from Calastone. Year-to-date data from Calastone indicated that investors withdrew £428 million from their property fund holdings.
Jefferies observed that declining rent certainty and shrinking developer profits were leading to diminishing investment market liquidity. They noted that London Real Estate Investment Trusts (REITs) might seem inexpensive but could potentially lack good value. (Please note that the exchange rate used is $1 = £0.8235.)
