Commercial real estate has faced a difficult twelve months. The challenging economic backdrop, rising cost of debt and continued discussion about working from home, resulted in a spotlight being shone more aggressively on the office sector. The central London office market was not immune. With total investment turnover barely breaching £7 billion, it’s evident that investor confidence was badly hit. 

However, with interest rates stabilising, and offices returning to higher occupancy levels, investors are seeing the impressive nuances of the London market, which justifies why we held our Prime City yield and Prime West End yields at 5.25 and 4.00 per cent respectively for most of 2023. 

In 2024 we expect to see the resilience and strength of the London office market become more apparent to a wider audience, but what else can we expect

Reset and rebound 

In the last few months investors have noticed that the London market is experiencing strong rental growth, high take up levels, and is in good fundamental health with vacancy rates at less than 10 per cent. Despite these solid fundamentals for much of core central London, we witnessed a precipitous fall in values in the past 18 months, thanks mainly to fast rising debt costs and an increase in investor return requirements. 

However, we carried out just under 1,000 sales presentations and over 550 inspections in 2023, with investors from all parts of the globe. With such interest in the market, and as debt costs stabilise and hopefully fall in the second half of 2024, we expect a reset and rebound for London, leading to what could be a strong period of growth over the next four to five years.

Economic impact and effect

With more stability, we’re hopeful that as inflation falls in line with the Bank of England target of 2.00 per cent towards the back end of the year, we may see even see interest rates reducing (the forward curve is suggested as much). This would, in turn, provide greater confidence to the lower cost of capital investors coming into the market. However, with a general election in the next 12 months, we expect to see more hesitancy from both business occupiers and investors in its lead up.

Flight to quality continues

2023’s main trend was the preference for core assets, either in location or quality, or both. We’ll continue to see a bias towards this stock, however, as supply of such product dwindles, a refocus on core plus or value add stock will increase. More confident steps will be taken to repurpose lower grade assets to feed the appetite from occupiers and investors for “greener” buildings. 

The collapse in pricing for this second-hand stock was particularly brutal over the past 18 months; in some cases it’s been as much as 50 per cent or more, thus allowing the investor a repricing to accommodate the increase in refurbishment costs, and an outward movement in the capitalisation rate. 

More debt distress

As values have fallen, banks have been willing to work alongside sponsors either by extending the financing for a limited period or agreeing to a consensual sale, rather than heading for the receivers or administrators. Unfortunately, potential stabilisation and market improvement in 2024 may come too late for many facing refinancing. It may embolden banks to push for a sale, particularly if the sponsor is unable to convince them that a well-thought through business plan is ready to implement, or fresh capital is unavailable to stabilise the financing.

It's clear that 2024 will be a pivotal year, and it certainly won’t be the same as the last 12 months.

Further information

Contact Stephen Down and Richard Garside

Central London Investment