Emma Mogford, manager of the Premier Miton Monthly Income, Income and Optimum Income funds, shares her outlook for the London office property market and explains why she recently added a London-focused commercial real estate company to the portfolios.
How bad is the move to hybrid working for owners of London offices? We see opportunities.
Expectations for capital value growth of London offices fell after the Brexit vote and just as they were starting to recover they were hit with Covid-19 related work-from-home (WFH). Recently, shares in Derwent London, a leading office real estate company traded at a 30% discount to its net tangible asset value, the sum of the estimated valuation of underlying properties. This tells us the market has a pretty negative outlook on the future value of those properties.
At the height of lockdown, some commentators speculated that with employees moving to hybrid working post pandemic, that an average 2-3 days working from home could lead to a halving of required office space!
However, as we start to adjust to a new normal way of working, the reality is much less severe. Below I lay out the reasons why required space will only fall a small amount in my opinion, but how we use the space is changing and that is more likely to determine the winner and losers in the next 5 years.
How much space do we need?
First it’s important to note that we never used 100% of leased space prior to the pandemic. CBRE estimate “occupancy of 70% was typical, including sick days, vacations, business travel, and remote work arrangements”.
Secondly as we return to the office, management must plan space for the busiest days i.e. you need to plan desk allocation for mid-week, not Fridays. In a recent study by Remit Consulting, they found average occupancy for West End offices had reached 37.6%, jumping up to 49.1% on a Tuesday.
While management might like to maximise use of space through ‘hot desking’, or as it is now called ‘activity based working’, this doesn’t suit all employees and the potential loss of talent may not be worth the saving. Savills anticipate there will be an 11% lower demand for office space in 2026 due to hybrid working and desk-sharing.
Available space in Central London Office remains elevated with a vacancy rate of 9.0%. It will take some time for this to return back to normal levels but the signs are positive. In the first three months of the year the take up of new space was back in line with the long term average.
Interestingly “under offer” is actually above trend which CBRE attribute to “flight to quality as large occupiers continue to commit to under construction or proposed space”.
The uncertain outlook has held back some developments which has led to a much lower level of new properties currently scheduled to open in 2024 and 2025. A lack of new supply could help bring available space down and push rents higher.
How is the space we need changing?
Employers are increasingly looking for property which can reinforce a return to the office, enhance workforce wellbeing and conforms with ESG strategies. This has lifted demand for high quality, energy-efficient and environmentally friendly Grade A office space.
There is increasing demand for new sorts of space in the office such as collaboration spaces and video call rooms. There is also an increasing focus on employee wellness with the installation of amenities such as showers and bike parking. BT’s new London office attempts to blend work and leisure with on-site yoga sessions, choir classes and a continental buffet bar.
So while demand for office space may fall, we believe it won’t be as bad as some fear. We think the bifurcation in demand for quality office space will be significant. By looking at the outlook post 2025, we find ourselves having a differentiated view of the investment opportunities in London office space.
At the end of May 2022, the Premier Miton UK income strategies* bought a new position in Derwent London. Derwent is a high quality property company focussed on London office space with a strong track record of delivering value from their development pipeline. As testament to the company’s long term resilience, the company has increased its dividend every year since 2007.