This quarter I am finding myself getting increasingly concerned by some of the views being expressed about offices:

“No one wants to buy offices.” But US$110 billion of office transactions have happened globally year-to-date.

“The drop in transaction volumes is much worse in offices than other sectors, like living.” But year-to-date figures show a 60% decline in global office volumes versus a 58% drop in living.

“The reason people are happy buying living and logistics at yields below the cost of finance is because at least there’s rental growth, which you don’t get in offices.” But rents are rising (to varying degrees) for prime offices in most of the major gateway markets across the world.

In London, for example, we are seeing rents on major pre-lets moving up dramatically. Clifford Chance agreed a rent of around £77.00 per sq ft at 2 Aldermanbury, a new build development, back in November 2022. Now HSBC has signed a pre-let at around £87.50 per sq ft in Panorama, 81 Newgate Street, an extensive refurbishment. That’s a 13.6% uplift in twelve months. We are even still seeing marginal growth in prime office rents in Los Angeles, despite a reported vacancy rate north of 25%.

Additionally, we have plenty of evidence of investment acquisitions being made below the cost of finance, maybe because these investors see the growth potential, maybe because they just believe in the long-term fundamentals of well-located office buildings.

We therefore need to challenge some of the negative views about the sector, or at least not automatically dismiss positive news or research as unbelievable and/or biased.

The biggest driver for the drop in office volumes is exactly the same as the drop in volumes in all the other sectors; interest rates and the investor discomfort of paying yields for real estate that are deeply below the cost of money. In offices, investors are also grappling with the rise in the cost of cap-ex. Again, extreme cost inflation is not unique to offices, but common to all sectors. The difference for offices is that there is an extra focus on meeting sustainability expectations and standards, which is generating additional cost at a time of market dislocation. So we have a double hit on value.

There is a well-rehearsed historical theme in the office sector of an undervaluation of depreciation and future cap-ex requirements in appraisals. People got away with this in rising markets, but not now. Cap-ex is something that can and is just being factored into appraisals right now. Once this happens, the bid gets lower and then we get to the other biggest cause for the drop in volumes; vendor price aspirations.

We are seeing some transactions going through right now, particularly in the UK and US, where price moves are 50%+ down on previous highs, in particular for development opportunities. Once again, if a like-for-like appraisal was done on a site for logistics development today versus 2021, the effects of rising costs, wider exit yields, and higher financing costs would also have an extreme impact on the residual number.

The next response I would expect at this point is that “there is at least leasing demand for logistics, which isn’t there in offices”. To that, I would say the evidence suggests there is demand for both, if one wants to believe it, and in fact in the UK take-up in central London offices this year is 11% down on the five-year average, while on logistics it is 41% below.

I am clearly strongly defending offices in this segment, but that is because this is a publication about offices. For clarity, I am absolutely not advocating offices above other sectors. What I am advocating is working with real evidence in the market across all sectors and geographies, and identifying areas that really have reacted to the change in the cost of money and other key fundamentals that are relevant to them and repriced.

Tenants are leasing offices and investors are buying them, and with the scale of asset value moves in certain situations, I can absolutely see why.

_{Read the articles within Taking Stock: Capital Markets Quarterly – Q3 2023 below.}