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Canary (Wharf) in the coalmine?

Prime office valuations have proved resilient throughout the pandemic. Could this be starting to change?
Canary (Wharf) in the coalmine?
  • Canary Wharf block sold at a cut price
  • Deal raises fresh questions for office valuations

Since Monday, people in England have been urged by the government to work from home “if they can”, as part of a series of measures to limit the spread of the Omicron coronavirus variant. As a result, offices are set to finish the year where they began: largely empty.

The advice hasn’t stopped dealmakers from working, however, even when the deal in question involves a major London office.

This week, M&G (MNG) agreed to sell 20 Churchill Place, a 16-storey office block built in 2009 and located in the heart of Canary Wharf’s business district. The building is home to the European headquarters of the American financial services giant State Street, though several upper-level floors are currently empty and in the process of being let.

The building's buyer, Brookfield Asset Management, is a Canadian alternative investment giant which specialises in long-life hard assets.

On their own, these details are unremarkable. Cash-rich international investors like Brookfield view prime London office assets as offering an attractive balance of risk and long-term yield, underpinned by the UK capital’s standing as “one of the premier global gateway cities that attracts talent from all around the world” - in the words of one major buyer of global commercial real estate.

What is most notable about the sale, first reported by The Sunday Times and confirmed by two people familiar with the deal, is the £250m price tag.

M&G has been looking for a buyer for 20 Churchill Place for several years. At the start of 2019, the group instructed agents Jones Lang LaSalle to sell the building’s long-term lease for a reported £300m, equivalent to a rental yield of 4.5 per cent. Within a year, Brookfield had expressed its interest in the property and entered talks, though negotiations were subsequently aborted with the onset of Covid-19.

The sales process was relaunched in June this year, the same month Brookfield acquired 30 Fenchurch Street for £635m, equivalent to a yield of 4.4 per cent, and a 35 per cent premium to the price that seller Safra Group paid in 2012.

It turns out that real estate prices can go down in London, though. In July, before Brookfield returned to the negotiating table, CoStar News reported 20 Churchill Place was on the market for £275m. “The market changes, and there are points in time where valuations change,” said one person with knowledge of the deal. Both Brookfield and M&G declined to comment.

As the deal is private, there are several big unknowns. The first is what premium M&G applied to its own valuers’ estimates in setting its original price. But given Brookfield’s reported pre-pandemic interest, one can only assume that it viewed £300m as reasonable starting point for negotiations.

Clip £50m off the price, however, and the 2019 reported yield stretches from 4.5 to 5.4 per cent. A widening in yield for prime London office space would run contrary to trends seen since the onset of the pandemic, according to research by Savills.

This again assumes the building’s estimated rental values have remained stable since 2019. Only M&G, Brookfield and its tenants are privy to this information. It is also hard to tell from lettings documents whether there has been a material change in tenants, and how long Brookfield might have to wait to attract new occupiers.

On this front, the outlook for landlords here is mixed. In recent months, floor space take up, offers and transactions have all been rising within the prime London office segment, amid a pick up in demand. This hasn’t translated into notably higher rents, however. One reason for this could be that occupiers have some bargaining power, as they have lots of vacant space from which to choose (see charts).

*Charts 1-3*

A challenge to valuations?

Investors in Reits with office exposure should not read too much into any one deal. For one, it seems clear the transactional market is still finding its feet.

Shortly after M&G put 20 Churchill Place back on the market, a note from Savills’ City office team said it was “not aware of a significant amount of assets being prepared for sale”, but that “those assets that are being openly marketed are attracting a significant amount of investor interest”.

Nevertheless, the agreed price of £250m marks a 17 per cent headline cut in an asset class that has been remarkably resilient over the past two years. Land Securities (LAND), one of the largest owners of offices in the capital, tentatively booked a 0.5 per cent valuation gain on its £5.2bn office portfolio in the six months to September after marking down the same holdings by 4.3 per cent in the year to March 2021. The previous financial year saw its office values rise 1.9 per cent.

Though office rent collections have held up well, some landlords in other parts of the commercial property market have expressed scepticism at the small net declines booked during a period in which the use case for the office has changed dramatically.

Other industry insiders remain convinced that valuations will hold up, especially in central London.

“The need for offices across the major cities across the UK hasn’t really abated,” says Chris Perkins, head of UK capital markets at M&G Real Estate. “The new normal is starting to bed down. When we emerge from the virus, there’s a very strong sense from occupiers that the hybrid model will come through.”  

Perkins, who was not involved in the 20 Churchill Place deal, believes that demand for “statement” office space with strong green credentials will continue to attract investors and occupiers, and prop up prices. “If you can provide that quality, it’s something large corporates will pay premiums for.”