Insight 3:

How London Will Recover

This Time?

Despite facing a global environment marked by rising interest rates, heightened inflation, and geopolitical shifts, London was the number one metropolitan area globally, for inbound real estate capital flows last year. London’s ability to navigate these challenges, albeit while still experiencing a reduction in investment volumes and adjustments in pricing, derive from three pivotal factors - price discovery, recovery capital and performance outlook.

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We believe that the future recovery of London’s commercial real estate sector is shaped by three critical factors:

Price Discovery: A critical phase of market realignment - the interaction between a peak in debt maturities and the crucial process of price discovery.

Recovery Capital: Stimulating market demand - the role of private buyers in spearheading recovery capital and identifying potential followers.

Performance Outlook: Setting the pace for recovery – the performance outlook will shape the market’s path forward. Whilst not yet clear of headwinds, we forecast evolving opportunities, across the risk spectrum, over the year ahead.

Price Discovery: A critical phase of market realignment

Price discovery is a pivotal phase where market realities are confronted head-on. This process is initially centred around vendors, particularly those under pressure to sell due to looming loan maturities. We anticipate that loan maturities for London offices will reach their peak this year.

Figure 1 Peak of Loan Maturities in 2024.

A significant portion of this peak can be attributed to acquisition financing. Traditionally, these loans are structured on a five-year term basis. However, what is particularly noteworthy in the current scenario is that many of these loans are maturing at a time when swap rates are significantly higher than when the loans were originated, as a result of ratcheting monetary policy driven by global economics and geopolitics. We are now at a point where we have started to see swap rates moderate from their peak as the conversation increasingly turns from when will central banks end rate increases, to when will they start to reverse. We also foresee an increase in equity injections and potential for the formation of joint ventures, especially with an anticipated increase in some investors from further afield. Joint ventures could become particularly appealing in larger projects or developments where the financial and operational complexities necessitate a collaborative approach. As we transition into 2024, there has already been a noticeable shift in the prime yields landscape, especially in areas like the City and Docklands. Indeed, the UK has acted as a forerunner for Europe in terms of yield shifts, although this is certainly not uniform across markets, risk spectrums and sectors. This phase of Price Discovery is critical in setting the stage for the market's next cycle. It involves a recalibration of expectations among sellers and buyers, leading to a more balanced and realistic view of property values and investment potentials. The outcome of this phase is crucial in determining the market's direction in the short to medium term and stimulating recovery capital.

Recovery Capital: Stimulating market demand

We have looked back at previous cycle shocks to the London commercial real estate investment market; Lehman’s collapse and the Global Financial Crisis, the Brexit Referendum and Covid to identify patterns of investors to gauge who will lead the market's recovery in this cycle?

Figure 2 Private Capital to Lead the Recovery.

Historically, private investors have often been the vanguard of recovery. Their agility, lesser reliance on upfront debt, and quicker decision-making capabilities position them advantageously to benefit from the current levels of thinner competition. We have already seen an uptick in investment over 2023 and expect this to continue into 2024.

Private equity firms have traditionally been at the forefront of capitalising on short-term recovery opportunities. However, the current cycle presents a different scenario. Many private equity firms are contending with more strained conditions in their base markets, particularly the US. This may result in a more measured re-entry into the London market.

UK Real Estate Investment Trusts (REITs) are currently outpacing private equity in seizing market opportunities having already invested £1.5bn in 2023 into the London commercial market versus £500mn for private equity.

Sovereign Wealth Funds (SWFs), traditionally slower in market re-entry requiring greater evidence and due diligence are expected to show renewed interest in liquid, gateway cities such as London, later in the year.

Performance Outlook: Setting the pace for recovery

Performance outlook is a vital determinant of the recovery's pace and momentum. In the wake of significant pricing shifts, investors will demand solid evidence of income growth potential.

Encouragingly, the prime segment of the occupational market is thriving. Prime rents are on an upward trajectory and the future supply pipeline, in part as a result of the significant cost-push inflation we have faced - is insufficient to meet the ongoing demand – a situation not witnessed in previous market cycles and will support the recovery.

More broadly, investors are seeking solace in tempered recession concerns, and sustained return to office trends. Medium term interest rate projections, crucial to exit liquidity, are also a source of comfort. Investors may well be considering alternatives - PRS, Student, Life Sciences -but should be aware that these sectors, though promising, are smaller in scale – and consequently, investors may encounter ongoing capital deployment challenges.

Valued at £206bn in 2021, the office sector remains the primary choice for genuine exposure to London and remains at the forefront of adaptability – with pricing adjustments aligned most transparently with borrowing costs and gilt yields.

While the recovery trajectory appears to mirror past patterns like the Global Financial Crisis, with a projected 6–9-month recovery window post the 2022 reflationary shock, the presence of significant dry powder and readiness of investors to engage upon suitable repricing may potentially accelerate this timeline. This dynamic market environment, underpinned by London’s resilience and strategic investor response, suggests a cautiously optimistic recovery outlook for the London office investment market.t challenges

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