Derwent flags further decline in rental values

Derwent London (DLN) expects further weakening in estimated rental values (ERV) this year after broader uncertainty led to tepid demand among occupiers in 2020. 

The office landlord expects ERVs to decline by anything up to 5 per cent compared with last year but said that the investment value of the portfolio should hold firm. 

However, there has been an increase in enquiries from prospective occupiers since the government announced its roadmap out of lockdown, chief executive Paul Williams said. “We have noticed in the last few weeks that tenants that have put space on the market to sublet have now withdrawn it,” he added. 

Last year subdued demand across the market among occupiers, who adopted a “wait and see” approach to signing new leases, meant rental values declined an average 2.8 per cent across the portfolio. Predictably, retail and hospitality assets - which account for 9 per cent of income - suffered a far greater decline of almost a fifth. The fall in office values was limited to 1.2 per cent and split between a 1.8 per cent decline in City Borders’ assets and a 3.3 per cent rise in the more resilient than the West End. 

New lettings amounted to just over a quarter of the level agreed in 2019 and were completed at an average 0.8 per cent below December 2019 ERVs. Meanwhile lease renewals and re-gears were completed at an average 7.6 per cent ahead of previous passing rent but 4.4 per cent below December 2019 ERVs. 

The EPRA vacancy rate ticked-up to 1.8 per cent at the end of December, from 1.1 per cent at the half year-mark. Yet that was above the 8.1 per cent rate across the broader London office market, an indication of an increasing bifurcation in demand for quality, grade A space - such as that offered by Derwent - and non-prime assets post-pandemic. 

The pandemic could exacerbate the dearth of prime office space, providing support to Derwent in the recovery. “Supply is [likely to be] quite constrained over the next couple of years,” said Williams. “I think you will probably see less development starts.”

A solid performance on rent collection might also give investors reason for optimism. That rate stood at 92 per cent, with a further 5 per cent of the amount owed under agreed payment plans. The shares trade at a 10 per cent discount to consensus forecast NAV at the end of December, after rerating markedly since November. However, there could be room for that rally to continue further given a possible squeeze in supply of prime London space. Buy.

Last IC view: Buy, 2,828p, 3 Sep 2020