Derwent acknowledges hybrid shift

Derwent London (DLN) provides something of a litmus test for the central London commercial property market. The real estate investment trust saw increased letting and asset management activity through 2021, both on par or in advance of estimated rental value. It meant that Derwent moved back into the black after 2020’s travails, yet chief executive Paul Williams highlighted “a distinct shift of emphasis among our occupiers to taking a more strategic and longer-term approach to their occupational needs”, before adding “hybrid working is here to stay”.

Presumably, landlords will also need to take a more flexible line with commercial real estate, but what that means for rental values is anyone’s guess. The central London office market remains in a state of flux. Overall take-up was well adrift of the long-term average, but Derwent noted a sharp increase in activity in the fourth quarter, so the amount of space under offer at the year-end nearly doubled.

There are two large developments and one smaller refurbishment due to complete in the first half of 2022, and work has commenced on the latest major development in London’s Baker Street, due for completion in 2025. The company notes that it has seen a marked increase in letting inquiries since the work from home guidance was lifted, but it’s too early to say what long-term impact the changes wrought by the pandemic will have on the leasing of retail space.

Industry metrics have improved but remain below long-term averages. We are seeing evidence of yield compression, and UBS recently pointed out that retail values have largely bottomed out, so we might reasonably expect revaluation gains going forward. Derwent saw a valuation surplus of £133mn in 2021, equivalent to 3.5 per cent (against a 3 per cent contraction in the prior year). The discount to net asset value still looks overdone. Buy.

Last IC View: Buy, 3,772p, 10 Aug 2021