Covid-19 - London: bracing for impact

What we know

A quieter start to the year.  London’s commercial property market has been supported by strong fundamentals since the EU referendum: diverse and robust demand from businesses, led by finance and banking, professional services, tech and flexible office providers; and yields which outstrip most global bond offerings and indeed most major European gateway cities. 

Against this backdrop, occupiers have been concerned with the lack of options on the market.  This helped to lift pre-let activity with the total proportion of stock available in newly completed schemes across London falling to 28% at the end of 2019; down from 75% in 2009.  

Leasing KPIs point to slowing activity. The strength depth of activity persisted well into Q1, however the unravelling of global growth due to Covid-19 began to erode market sentiment in early March, with total take-up ultimately dipping to around 2 million sq ft in Q1, down on Q4 2019 (3.4 million sq ft). The long-term quarterly take-up average is 3.3 million sq ft. 

Rent holiday requests on the rise.  Cash flow pressures stemming from slowing economic growth have resulted in a rise in rent holiday requests. The Covid-19 pandemic happens at a time of record high rents in all submarkets, so this is perhaps unsurprising.  The government’s emergency Corona Virus Bill effectively grants a moratorium on forfeiture until 30 June, which offers some temporarily relief. The Bill effectively means that tenants are not obliged to pay rent for the next three months.  They are however still liable for the missed rental payments in the future.  

As a result of this and financial pressures, there have also been several instances of non-payment of rents. Partnerships between landlords and businesses will be critical at this time as they work together to develop new payment plans and timelines. 

Investment deals being scrutinised even more closely. As the Covid-19 crisis bites, investors and lenders are moderating their appetite for London assets. Our sentiment indicator is showing that deals are being reviewed, or are stalling as investors reassess the situation, but those committed to London are still transacting and showing interest.  Most lenders are still “open for business”, but are reluctant to make new commitments, citing the still unknown impact on commercial values, which will almost certainly curb investment activity in Q2.

What the numbers show. Provisional data for Q1 shows investment turnover of close to £2.3 billion (LTA: £3.4 billion). The decline has been precipitated by the impact on sentiment as a result of Covid-19, the inability to carry out property inspections and the lack of investible stock. We started the year with just £2.3 billion of assets for sale, 60% down on the LTA, spread across 40 schemes.

What we expect

Short term challenges for flexible offices. Flexible offices could face a tricky situation in the short term as social distancing rules are enforced, but the medium-to-long term prospects are better: they could offer a stop gap solution to those businesses impacted by fit-out and/or construction delays. 

Furthermore, like some markets in Asia, they can offer a stop-gap remedy to businesses looking at their staff density ratios in the wake of Covid-19 as social distancing rules become the new normal.

Whilst Covid-19 will test serviced office business models, it will also reinforce the place of a formal work environment.

London to remain a safe haven. During times of global economic or geopolitical tensions, locations such as London have emerged as an investment safe haven. However, those investors who take a long-term view are likely only to deploy capital once there is clarity on the true economic impact stemming from current conditions. 

Opportunistic investors, driven by the hunt for returns may temporarily move into a holding pattern as covenant strengths are reassessed. Indeed, debt funding challenges may also cause an investment hiatus. 

Travel curbs will impact inspections.  With signs of long-term investment strategies remaining in play, London appears to be assuming its position as a trusted global safe haven. The biggest challenge for investors of course will be the far-reaching travel restrictions that has seen countries close their borders and ground airlines, which clearly will hamper property inspections.  This is particularly important for London given that 75% of investment was from overseas in 2019.

BA has stopped flights from London Gatwick, London City Airport is closed to commercial flights and Emirates, the world’s largest international carrier, has grounded its entire fleet, to name a few examples. 

Our Global Capital Tracker, launched at the beginning of February showed £48.4 billion waiting to deploy in London’s office market from around the world (up 21% y/y). The volume of capital chasing assets in London may well become further supercharged, depending on the length and depth of Covid-19’s impact on the global economy.

What we question

The need for an office.  Our 2020 London Landlord and Investor Survey revealed three key areas of focus for London’s largest landlords and investors: services, amenities and experiences, all of which revolve around the way in which we are using office space.  The office has a newly elevated status in the minds of businesses as a tool in the war for talent. Offices are a window into an organisation’s culture and an extension of our personal lives.  More importantly perhaps is that they are a place for innovation and collaboration.  

If the last two weeks have taught us anything, the much touted “death of the office” concept couldn’t be further away from the truth.  Granted that the daily commute may no longer appeal to all staff and occupational densities may need to be revisited once things normalise, but the need for a central hub and formal work environment has been overwhelmingly reconfirmed by our enforced remote working.

Supply and demand not necessarily the best indicators of market health.  One of the factors underpinning rental growth in London over the last 10-years has been a supply-demand mismatch.  With construction sites now being closed due to Covid-19, project delays are inevitable.  While this may exacerbate the challenge businesses face in finding suitable options, demand will also almost certainly be dampened by current conditions. 

The weakening in both requirements and available stock may well cancel each other out, but we are yet to fully understand how this crisis will impact occupational strategies.  The supply-demand equation may not be able to paint as black-and-white a picture of the market’s health as it has done historically.