Q2 2020 South East Office Investment Market Snapshot

COVID-19 has brought continued uncertainty and volatility to the property market since its effects were first felt in early March. Turnover in the office sector has however remained very resilient when compared to other sectors. This is due to high income yields on a risk adjusted basis, strong occupational dynamics coupled with one of the strongest rent payment records of any sector.

• Significant contraction in availability of investment stock – this has been compounded by offices (and industrial) being retained given their defensive characteristics in the face of collapsing retail values.
• There were a large number of deals under offer at the end of Q1 20 20, following a period of high activity and renewed sentiment post the General Election. Whilst some assets transacted in late Q1 / early Q2 a large proportion of deals were put on hold and are likely to be reinvigorated.
• ACRE are now seeing an encouraging week-by-week improvement in sentiment with investors starting to get busy and focusing on the strong fundamentals of the sector, which we expect to translate into improved Q3 investment volumes.
• We believe that the improvements observed over the last two weeks reflect the positive indicators below:

• Whilst COVID-19 has resulted in significantly reduced investment volumes for Q2 2020, the H1 / YTD investment volumes at £1.47 billion demonstrate strong resilience in the sector when compared to other sectors.
• The conundrum that the market faces is navigating a potential second spike and the economic fallout allied with a hard Brexit.
• The trend for a number of new opportunities being offered off-market or on a selective off-market basis has and will likely continue through 2020 as vendors cautiously look to test the return of market appetite and investors ability to transact.
• The largest Q2 2020 deal was Tristan Capital Partner’s acquisition (exchanged only) of Reading International Business Park (£120 million). In terms of the pricing impact, we have seen this to be on an asset by asset basis – with pricing on deals with more defensive characteristics unaffected.
• The deployment of capital remains focused on well positioned core assets with strong property fundamentals and covenants or assets with alternative development angles reflecting the continued background of uncertainty.
• We have continued to see new overseas parties enter the market looking for opportunities in the sector. We expect private equity core plus and value add to be the dominant player in Q3 / Q4 2020, something they haven’t been in a long time.

• The impact of the June Quarter day in terms of rent payment is still being analysed and is unlikely to flow through before the end of the summer. However, its likely to have a big impact on a number of senior lenders and their immediate capacity to write new loans. Although, our intelligence suggests that many expect/need to return in Q3 / Q4 and have ambitions to still achieve their annual targets.
• Overseas banks are cautiously putting toes back into the market although senior debt margins have moved out anywhere between 20 and 100bps.
• Senior leverage is really capping out at 55% max now (leverage down at least 5%). The tone on South East offices is now 50% LTV.
• Debt funds, however, are still hungry and well capitalised although pricing is 100-150bps wider than pre-COVID-19.
• Lenders taking a view on valuation and starting to be able to write loans even whilst the MUC clause remains in.
• Deals are still getting done. Brotherton closed c. £150m since lock down over 8 deals and have over £100m recently credit approved. It is certainly harder to find the right lenders than before COVID-19 but appetite is changing on an ongoing basis amongst lenders.

The office sector has not just shown resilience in terms of rent payment and transaction volumes, it also offers a highly attractive income yield on a risk adjusted basis.

• The pandemic has resulted in sensational headlines around the ‘death of the office’. This theory in our view is short sighted in that it fails to recognise the shortcomings for businesses and employees from extended working from home in terms of productivity and mental health.
• We strongly believe that as the benefits of offices are re-embraced and witnessed with more returning to the office over the next few weeks, the permanence of the office will be both realised and relished. We can ‘get by’ at home but the office enables growth!
• Nonetheless, we expect to see significant changes over the next decade to the fundamentals for a successful office. Some of our key thoughts and the influencing factors are outlined below: