Diversification, income conviction and future-proofed assets: key capital market trends for 2021

How has London fared in the past 12 months?

Prime core investments have been hotly contested as investors have been attracted to London’s safe-haven status. The discount that London offers to continental Europe (prime yields in the City of 4.00% and West End of 3.50% against 2.75% in Paris and Berlin); the low-interest rate environment; and the removed threat of a no-deal Brexit, have all led to best-in-class product performing strongly with a number of transactions taking place without the purchaser physically inspecting.

Some key highlights of prime core transactions trading at pre-Covid pricing levels over the last 12 months include our sale at 1 St John’s Lane (7 years of RPI linked income at 3.39%), 21 St James’s Square (11 years of income trading at over £3,000 psf) and London Wall Place (17 years of income in the City at 3.75%).

At the other end of the risk spectrum, prime value-add opportunities have arguably been more competitive, with investors focusing on building fundamentals and ensuring that they are able to deliver a product that will be attractive to increasingly selective occupiers. This has led a number of core funds to employ a develop-to-core business plan with a lower cost of capital than the traditional value-add investors. The reverse effect of this has been a softening on pricing for properties demonstrating any secondary characteristics with market pricing particularly sensitive on these assets leading to multiple fractured or failed processes for such stock and a high level of market availability as a result.

Over the course of the last year, we undertook a number of best-in-class value-add sales, benefitting from the acute shortage of such stock, these included 20-24 Kirby Street, 7 Soho Square, 127 Charing Cross Road and 27 Savile Row, on which we undertook over 200 inspections and received nearly 60 offers.

In summary, the last year has seen a shortage of well-priced, best in class opportunities, leading to increased develop-to-core business plans, a growing disparity between prime and secondary, a real focus from investors and occupiers on fundamentals, and finally, the importance of market pricing in maintaining investor engagement.

 
What is the outlook for the next 12 months?

In our opinion, this can be split into the following four key themes;
1. Continued flight to quality
2. Diversification
3. Income conviction
4. Future proofed assets

1. Continued flight to quality

We expect best in class London assets to continue to outperform secondary markets and stock as the capital continues to benefit from its status as a safe-haven. The prime occupational markets in global gateway cities are therefore also likely to outperform and remain resilient over the course of 2021.

Vendors are likely to see this as an opportunity to benefit from the huge amounts of capital targeting prime, core and value-add opportunities, and owners with upcoming capex events and limited appetite for risk may see this as an opportunity to exit.

Do not be fooled by the headlines though, premium pricing is reserved for these best-in-class assets, and secondary stock will remain price sensitive.

2. Diversification

As global institutions look to ensure their risks are adequately hedged across the major economies, we expect London real estate to be a net beneficiary of a diversification drive.

Diversification is likely to lead to transactions of scale as large domestically dominant institutions look to spread their risk.

3. Income conviction

Businesses have faced unprecedented challenges in the past 12 months. This will lead to increased scrutiny and testing of covenants, with premium pricing being achievable for ultra-secure income, which will continue to attract bond replacement capital. The sale and pricing achieved on London Wall Place is a good example of this.

The ongoing trend of shortening and Cat B leases is only likely to exacerbate this theme, as genuine long-term secure income becomes rarer.

4. Future-proofed assets

Gone are the days where developers could build an asset just for the legal or the financial sector. Occupiers have become increasingly footloose and focused on best-in-class product, and therefore flexibility, ESG and talent-attraction will all continue to be key considerations.

For more details please contact the team