As advisors, we enjoy a privileged (in my view) window into the world of real estate. Some of us work across many sectors and markets, while others maintain a tight geographical focus, or specialise on a single sector. Either way, we get to speak to investors of all types on a daily basis – big to small, institutions to privates, opportunistic to core, etc. We get to hear their views, and discuss investments that match their requirements across a huge spread of assets. When we are selling assets, it is only ourselves and our client that really know what the true appetite, the spread of bids, and feedback are. This gives us context.

Investors have it much harder. Unless they are going through live sales processes on their own assets, they are tasked with navigating markets with partial information, largely obtained from second-hand sources, from which they need to form very meaningful judgements. While I consider our markets to be fairly transparent and largely occupied by professional advisors, there is no doubt that investors don’t always know who they can trust. If they hear positivity in an environment like we are in at the moment, there is a natural inclination to be cynical. After all, in real estate, investment advisors only get rewarded when things happen.

With office transaction volumes woefully low in most major markets across the world for Q1 2023, advisors and investors are struggling to answer the most simple questions around true pricing, liquidity, and demand.

I went through much of Q1 feeling relatively positive. Inflation was supposedly nearing its peak and, therefore, so was the interest rate journey. I felt pricing in some markets was looking well adjusted, led by the US, UK, and pockets of Asia Pacific, and we saw an uptick in office transactions from Q4 2022, in London in particular.

However, I feel we are now in another moment of pause and reflection. There are a lot of questions over ‘the pivot;’ if, when, or are we now higher for longer? Journalists have a new-found lust for being negative about commercial real estate, and what they really mean is offices, often with little data. However, the biggest challenge is the negative sentiment towards offices emanating from the US that has now truly gone global, to the extent that it is seemingly easier for many investors to just go with that flow (if it happens in the US, it must be right), rather than try and justify an office acquisition to their investment committee. This is despite many acquisition teams actually recognising situation-specific value.

So where do we go from here? There does seem to be a consensus amongst investors that things will get better following this period of relative unease. At this point, I’m not really sure that it’s just a question of pricing. It’s more a case of getting past fear. We have seen major value erosion, but we aren’t seeing major global investors (in particular from North America) making moves in the sector yet in any great volume. I feel this will be a bigger catalyst for activity levels recovering, more so than further price moves.

In the meantime, it is incumbent on us as advisors to help our clients navigate this negative rhetoric and not throw the baby out with the bathwater. Not all offices are bad, and not all the bad ones have no future. In addition to the price moves we’ve had, there is plenty of data to support tenant demand and rental growth for the right office buildings. There is, of course, a future for office investment. It needs deep and nuanced analysis, market by market, coupled with good advice. Like with most things, fortune will favour the brave.

Key transactions

Methodology

Net initial yields are estimated by local Savills experts to represent the achievable yield, including transaction and non-recoverable costs, on a hypothetical Grade A building located in the CBD, over 50,000 sq ft in size, fully let to a single good profile tenant on a long lease. The typical LTV and cost of debt represent the anticipated competitive lending terms available in each market. Cash-on-cash returns illustrate the initial yield on equity, assuming the aforementioned LTV and debt costs. The risk premium is calculated by subtracting the end-of-period domestic ten-year government bond yield (as a proxy for the relevant risk-free rate of return) from the net initial yield. Data is end-of-quarter values.

_{Read the articles within Taking Stock: Capital Markets Quarterly – Q1 2023 below.}