Positive momentum in the market at the end of 2021, and the continued strong investor appetite we saw during this period, resulted in Central London investment turnover for the first quarter reaching £6.1bn, with around 70 assets trading. This was a new record for a Q1 period, with the freehold interest in UBS’s headquarters at 5 Broadgate, EC2 being acquired by LaSalle Investment Management, on behalf of NPS, for £1.2bn, and Google’s freehold acquisition of Central Saint Giles, WC2 for £773m, exchanging.

However, since then, there has been a substantial shift in the economic outlook with the ongoing conflict in Ukraine, inflation currently forecasted to reach 13% by the end of the year with the rise in the energy price cap and a forecasted protracted recession and the resulting increasing interest rates, build costs and increased cost of debt. Within a 12-month period, the five-year SONIA swap increased from 0.47% in June 2021 to 2.6% at the end of June, having peaked at 2.8%. (Though this has now come down and is at c.2.4% at present).

The volatility in rates limited the number of market participants, particularly those debt-backed buyers, and as a result of the higher levels of uncertainty, we saw a subdued level of activity over the second quarter, with turnover reaching £2.88bn. This was down 48% on the previous quarter and 28% on the long-term Q2 average.

Despite the lower level of activity we saw in Q2, investment turnover at the end of the first half stood at £9bn, which was up 30% on the ten-year long-term average. The largest transaction to complete during Q2 was GIC’s acquisition of a 75% stake in Paddington Central, W2 from British Land (who retain the remaining 25% share) for a reported £694m (purchase reflecting a 4.50% NIY and £1,224 psf across a range of assets). In another transaction of note that Savills advised on, on behalf of a private Asia Pacific investor, was the acquisition of 2 London Wall Place, EC2, (pricing remains confidential).

Overall, international investors continued to be the main driver of activity and accounted for 77% of H1 turnover. We saw the return of Asian investors during the first half of 2022, and they accounted for 40% of turnover – this is up from 17% at the end of H1 2021. UK investors followed with a 23% share, followed by European investors, who we have seen muted activity from over the first half of the year, with 6%.

Institutional investors accounted for 43% of H1 turnover, which was up 6% on the same period a year earlier. Investment activity in the City, historically, has been driven by a greater volume of institutional money, with institutional investors having accounted for 40% of turnover since 2016 in comparison to the West End, where private investors have accounted for the largest share, 35% of turnover (followed by institutional investors with 25%).

Whilst a reasonable volume (just above the five-year average) of transactions completed, overall capital still continues to be heavily weighted towards the bigger lot sizes, with £100m+ transactions accounting for 80% of the volume to complete so far this year.

Despite the headwinds, at the end of June we were tracking purchasable stock on the market at £7bn, up 22% on the volume at the end of the same period last year. The volume of stock under offer was also at a high level at £5bn, with the weight of under-offers also heavily weighted towards the larger-sized lots (with the £100m+ lot size accounting for 76% of turnover under offer across 12 assets at the end of June).

Encouragingly during the past month since the end of H1, we have witnessed an unprecedented level of investment activity in the West End in contrast with the traditional lull in activity during the summer months. As a result of the high level of activity in the West End, Central London, July turnover has reached £1.1bn. Further to this, the volume of stock under offer continues to remain at £5bn, and available stock has increased to £7.7bn.

We will be closely tracking the assets which are currently under offer as the outcome will set a strong precedent for pricing of new sales during the second half of this year. Going forward, we expect to see investor appetite tempering as higher than average levels of inflation and increasing cost of debt financing remain at the forefront of investors’ minds, but the focus on Core long income secure assets, and for office buildings with high green credentials, and demand for these assets to support pricing of best-in-class assets.

The West End Prime yield remains stable at 3.25%, but we moved the London City prime yield out by 25 bps to 4.0% at the end of Q2, although the outlook for the next 12 months is a little more encouraging as we are starting to see investors’ focus turn to the depreciation in GBP, which has lost around 13% in value against the USD since the beginning of the year, and 5% against a basket of the UK’s major trading partners versus a number of major global currencies including HKD (9.29) and USD (1.18) as an opportunity for cash buyers who are looking to deploy capital at a historically attractive rate. The consensus is for the pound to end 2022 at USD 1.24 per GBP and 2023 at USD 1.30 per GBP.

London’s reputation as a global city has kept it attractive to investors worldwide, particularly as risk premiums are currently attractive compared to other European and global gateway cities. Although the average European yield was up 20 bps, at 3.7%, from 3.5%, with most European city office yields holding firm or moving out during Q2 2022, as we saw debt cost continue to rise across European markets, for example, total debt costs in Frankfurt, Madrid, and Paris moved out 120–140 bps on the previous quarter.

London City and West End prime yields remained in the fairly priced territory in our Q2 European value analysis, supported by forecasted real rental growth over the next five years. Investors will be paying close attention to how inflation will impact interest rates over the next 12 months and how this will impact debt terms on refinancing in 2023.

Methodology

Savills EME Office Value Analysis compares the fair-market (calculated) yield relative to current market pricing across 24 EME markets. An investor must be compensated for bearing the risk of investing in real estate over sovereign bonds. The calculated yield is derived as the current risk-free rate plus five-year average office risk premium, discounting for nominal rental growth, inflation and expected depreciation forecasts across each market. The calculated yield represents a hypothetical yield assuming a fully liquid market and that the investor is fully hedged against currency risk. Calculated market yield pricing > 50 bps above market pricing we consider underpriced. Calculated market yield pricing within 50 bps of market pricing we consider fairly priced.

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