The Reality For Bad Offices Is So Much Worse Than Most Thought, Industry Leaders Say

Real estate valuation indexes suggest that office values are down by 25% to 30% since the prepandemic peak.

But the average figure spit out by an index hides a much bleaker reality for the kind of office that no longer makes a tenant’s heart sing.

“Outside London now, with offices that aren't absolute best in class, values are, on a good day, half what they were. On a bad day, a quarter. It's staggering how much the value has collapsed,” BNP Paribas Real Estate UK Head of National Capital Markets Hugh White told the audience at Bisnow’s London Real Estate Outlook event.

“If you look at the MSCI figures, they're talking about being 20% off. It's never that. The reality is far, far worse.”

There is good money to be made from buying quality assets and improving them, according to panellists at the event, held at Legal & General and Mitsubishi Estate London’s 245 Hammersmith Road scheme. And recent political events on both sides of the Atlantic make the buying window for those with money and conviction a lot longer. Private equity firms are starting to sniff an opportunity. 

But a combination of continued inflation and ever-increasing tenant demands on amenities and sustainability mean that many office assets are in limbo — unfit for purpose as offices, but unable to be converted. 

White's comments primarily referred to offices outside of London, in areas like the commuter belt of the south-east, where working from home meant there was little demand for out-of-town offices, or places where the rents that could be commanded by upgrading assets did not justify the cost of upgrading them.

Yet London is facing the same issue.

“There are piles of secondary offices out there, either in the wrong locations or which just are not fit for purpose,” GPE Senior Investment Manager Alexa Baden-Powell said. “And if you run appraisals on them and you try to estimate the amount of capex you've got to invest to really turn them around, it just doesn't stack, because the office rents are not going to be what they were on those offices.”

In London especially, offices are being converted to alternative uses, including Dominus and Cheyne Capital's purchase of the 325K SF 65 Fleet Street, which is being converted to an 850-room student accommodation scheme.

“We’ve seen offices on Fleet Street go to student accommodation, something we never would have seen before,” Baden-Powell said. 

“You need to squash down the entry price to make redevelopment stack up,” White said. 

Still, there is money to be made for good-quality offices, either new developments or the upgrading of better older buildings, panellists said. 

Ontario Teachers Pension Plan Senior Managing Director Jenny Hammarlund said inflation is likely to remain elevated over the coming years, and the panel pointed to the recent UK government budget and Donald Trump’s U.S. election victory as reasons why. 

That could mean interest rates are not going to come down as fast as had been hoped, Hammarlund said, making it more difficult for debt-backed buyers to come back into the market. 

But for those who do have cash, now could be the time.

“If you asked me this time last year what interest rates look like in 2025, I think I would be expecting a faster rate of cuts than we're going to see,” Baden-Powell said. “But that's fine. That just means we're extending the buying window. We think we've got longer to take advantage of this point.”

GPE raised £350M of equity in a rights issue earlier this year, and it has spent about a third of it, Baden-Powell said. The company expects rents on quality London offices to rise by 5% to 10% next year due to improving demand from tenants and a lack of supply. New office stock has been limited by the same inflation-driven cost rises that make it expensive to improve older assets. 

“We look for light-filled, flexible floor plates with buildings where you can put in external terracing courtyards and also roof terracing,” Baden-Powell said. “You want private and communal space. That is what customers of today want.”

L&G is also buying. Having shied away from London offices in recent years, it has spotted value in the market, purchasing 30 Golden Square in the West End and 38 Finsbury Square in the City in recent months. Both assets are set for comprehensive refurbishment on the thinking that rents will improve. 

“With 30 Golden Square, the number of competitors, although it was a competitive bidding process, it was nowhere near as strong as it would have been in the past,” L&G Investment Management Senior Asset Manager Nick Wells said. “That meant that we were able to pick up an asset which we probably would never have dreamed of looking at a few years ago.”

Private equity firms with core-plus mandates are among the major buyers in the market now, happy to take returns of 10% to 12% for buying high-quality offices in areas like Mayfair that may need low-level refurbishment.

Deals like Ares' £135M purchase of 80 Pall Mall fit that bill, and both Baden-Powell and Wells said they had seen significant numbers of private equity bidders on assets they have acquired in recent months. 

But for the market to really start firing again, core investors like L&G need to start to become significant investors again, BNP’s White said.

A lot of the opportunities on the market are riskier retrofitting plays. Those offer good returns of 22% or better in many cases, but institutional investors simply don’t want that kind of risk right now. 

“What I’d like for Christmas is the return of long-term, core investors across the wider markets,” he said.