Boom or bust? London’s biggest office landlords brace for Brexit fallout
- Most London-focused developers are trading at wide discounts to the value of their assets because of the risk that Brexit will cause rents and values to fall
London’s biggest office landlords face an unprecedented situation – a political fork in the road that could send the real estate market in polar opposite directions.
Developers such as Land Securities Group, British Land and Great Portland Estates are grappling with uncertainty surrounding the UK’s departure from the European Union through a combination of paring down debt, postponing large-scale developments and squeezing more out of existing projects.
“Clever management is all about managing those options and being appropriate with risks,” Toby Courtauld, chief executive of Great Portland Estates, said in an interview. “We are really trying to have our cake and then eat it, whatever happens to the weather outside.”
Even as the odds of a no-deal Brexit have come down of late, political turbulence has disrupted the typical boom-and-bust cycle in the world’s most liquid property market. The process of committing to new developments over a multi-year period remains a risky proposition. Yet, if the office market manages to avert disaster – as it has since the 2016 referendum – companies that do not have a pipeline of properties in the works face the prospect of missing out on years of profitable growth.
The dilemma for most office Reits is really whether to build. Land Securities, the UK’s largest real estate investment trust, stopping building on a speculative basis four years ago. The firm decided to secure tenants before developing properties to counter the risk of oversupply in a market that was heating up.
It has instead focused on filling existing properties with tenants on long leases, while reducing debt. The firm has also been pushing performance through refinancing and returning capital to shareholders. Land Securities will soon have to decide whether to resume projects without securing tenants beforehand – the first of three potential developments will be ready to start work as early as March, the same month in which Britain is due to leave the EU.
“I don’t think we will make a decision three weeks before Brexit,” CEO Robert Noel said in an interview. “No one knows quite what is going to happen, but we approach Brexit with an appropriate balance of low current risk and exciting future prospects.”
British Land, the second-largest of London office Reits, has been rewarded for taking a more bullish approach in the past two years. The company has a pipeline of big new leases for projects it started in recent years without the assurance of new tenants. The firm has also divested two of its most valuable London office buildings since the Brexit referendum, as overseas investors – encouraged by the pound’s weakness – are still willing to pay high prices.
Still, British Land is not ignoring the risk of a crash. Instead of developing the site of an office building vacated by UBS Group AG in 2016, the company has refilled the existing premises by offering tenants short-term leases. The Reit intends to carry out the project at some stage, but for now it’s focusing on smaller developments and less costly refurbishments.
“What we like about all of that is the optionality that we have,” said Grigg. “And that is obviously relevant in the context of current circumstances.”
Adopting a cautious approach has not prevented Reit shares from falling. Most London-focused developers still trade at wide discounts to the value of their assets because of the risk that Brexit will cause rents and values to fall. That, together with a lack of cheap opportunities to buy plots for future projects, means most landlords are finding it hard to replenish their development pipelines.
“We find it tough in the UK,” JPMorgan Chase analysts including Tim Leckie wrote in a note on Friday. “Most management teams have done a good job navigating this unconventional property cycle, but the outlook is challenging.”
Companies are using funds raised from the sale of completed developments to return capital to shareholders or undertake buy-backs. Great Portland Estates announced its second buy-back programme in less than a year this month, which will push its gearing from less than 6 per cent to a still modest 11 per cent.
“It’s all about balance, and it’s a pretty tricky balancing act right at the minute,” said Courtauld.