Derwent’s multibillion-pound portfolio of London office blocks suffered another fall in value last year, but the landlord has hinted that Britain’s commercial property market may be near its bottom.
The feeling of optimism was reinforced as investors backed plans for expansion at Segro, Europe’s biggest warehouse owner, with £100 million more than it had asked for.
The combined value of Derwent London’s offices, most of which are in the West End of the capital, dropped by a further 10.6 per cent in 2023 to £4.9 billion, having fallen by almost 7 per cent in 2022. Commercial property valuations have sunk over the past 18 months in response to spiralling interest rates.
However, in Derwent’s view, “valuations are now approaching this cycle’s lows”. Paul Williams, the group’s chief executive, said: “We’re getting there after a difficult 18 months. Inflation is now much more under control and I think people expect base rate cuts later this year. We’re feeling a bit more positive.”
Although valuations have tumbled across the board, even in more popular sectors such as logistics, sentiment towards offices has been especially negative, given the uncertainty about future demand because of working from home.
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Williams, 63, accepted that hybrid working was “here to stay”, but pointed to his company’s strong leasing numbers last year as evidence that the office was far from dead. Derwent signed new lettings adding £28.4 million to its annual rent-roll in 2023, three times more than it had recorded in the previous year and up with its best years.
Landlords and agents have reported a “flight to quality” since the first lockdown ended, with company renters increasingly interested only in working from the best buildings.
“There’s good occupier demand for the right space,” Williams said. “Amenity is pretty important. Sustainability is right up there and it’s not remotely going away. Occupiers are more selective and demanding. They not only want space that looks good but they also want green space. You’ve also got to be close to transport.”
While all the demand is for that best-in-class space, high financing costs, the slow planning system and lingering uncertainty about office space mean that little is being built and supply is tight. As a result, rents for “prime” offices are heading higher. Of Derwent’s lettings last year, on average they were agreed at rents 8 per cent above valuers’ forecasts The company expects its rents to increase by 2 per cent to 5 per cent this year, slightly better than it had predicted previously.
Derwent’s rental income for the 12 months to the end of December totalled £212.8 million, a 2.8 per cent increase on the £207 million it made in 2022. However, because of the drop in valuations of its buildings, the group fell to a pre-tax loss of £475.9 million, wider than the £279.5 million loss it suffered in the previous year. Net tangible assets per share fell by almost 14 per cent to £36.32. Despite that, the final dividend, which has been increased every year since 2007, rose again by half a penny to 55p. It will be paid on May 31.
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The upbeat outlook excited analysts. “With management effectively calling the bottom, perhaps now is the moment to invest,” James Carswell, an industry analyst at Peel Hunt, suggested.
Investors were certainly happy to hand over their money to Segro, which had been looking for £800 million to buy and build more warehouses but ended up getting £900 million, such was the “strong demand”. That was more than all British property companies had managed to raise throughout all of last year.
Denese Newton, an analyst at Stifel, said the fundraising was “a significant step in indicating that equity markets have begun to open for the right opportunities”.
Reflecting the small discount at which the new shares were offered to investors, Segro’s share price slipped 4¼p, or 0.5 per cent, to 845p. Derwent London’s shares edged up 2p, or 0.1 per cent, to £19.17.
Analysis
Traders are betting that not only have interest rates peaked but also that a cut is coming this year (Emma Powell writes). That should signal property values are stabilising, yet shares in some of London’s largest commercial landlords still trade at heavy discounts to their respective net asset values.
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The commercial property sector is priced for disaster. During the 2008 financial meltdown, all property capital values fell by 42 per cent peak-to-trough over nine quarters, according to an analysis by Savills, the estate agency. The Covid downturn resulted in values falling by just over 9 per cent, but some corners of the real estate market are priced for an even heavier fall from today’s muted levels. That suggests the risk of a further deterioration is already accounted for in depressed share prices.
Take Derwent London, whose chief executive has called the bottom of the market. Shares in the FTSE 250 landlord trade at a 41 per cent discount to the book value forecast in 12 months’ time, indicating that investors mistrust that the fall in the value of its west London offices is over yet. Some scepticism over where valuations will land is understandable. Net tangible asset values declined by 9 per cent over the final six months of last year, which is roughly in line with the fall sustained over the second half of 2022.
Derwent is not alone: Great Portland Estates and Helical trade at similarly wide valuations. It reflects more fundamental questions over the future need for office space after a lengthy compression in the yields, rents expressed as a proportion of property values, over the past decade.
However, there is reason to think that other corners of the property market are closer to the bottom. For Segro, the warehouse landlord, the decline in asset valuations slowed to a mere 3 per cent during the final six months of last year. Rental values were 6 per cent ahead last year. The shares are still priced 12 per cent lower than forecast NAV. LondonMetric has stabilised even faster, with underlying valuations marginally positive during the first six months of the year. That is yet to be reflected in the shares’ 10 per cent discount versus the forward book value.
Both industrial property groups are forecast by analysts to report higher portfolio valuations at the end of this year, in contrast with some of the largest office landlords.
