Oversupply, not Brexit, biggest risk for London
Barclays Plc's decision to cut 25pc of its London office space highlights the growing risk that tenants will be in short supply for developers of buildings currently being constructed.
The lender is seeking to sublease offices in the Canary Wharf financial district to the UK government, according to two people with knowledge of the matter. They asked not to be identified because the information is private. It shows how space that was previously occupied can suddenly come back on the market as companies downsize, providing more competition than investors expected.
Developers sought to capitalise on escalating rents by starting work on a record number of central-London office projects in the six months through March - making oversupply a bigger threat to rents and values than Brexit, UBS Group AG said in August.
Construction began on 51 office buildings in central London during the period and the amount of space being developed almost doubled in 18 months, Deloitte LLP said in a report issued last May.
Companies could shift as many as 100,000 jobs away from London within two years of the UK starting the process to leave the European Union, Jefferies Group LLC analyst Mike Prew wrote in a note to clients in June. That's the equivalent of 20 skyscrapers the size of the Gherkin building, he said.
"Tenants are getting the upper hand in rental negotiations, with banks optioning space to relocate from London," Prew wrote in a note to clients last Monday.
"Property yields may give the illusion of looking screamingly cheap, but we have expected rising yields since August 2015."
Barclays' space cut, for which the bank took a Stg£150m (€166m) charge in the third quarter, will probably be completed in the next two weeks, Chief Executive Officer Jes Staley said in an October 27 call with analysts. It's the equivalent of about 5,000 desks. The reduction in office space came after a hiring freeze was put in place, a spokesman for the bank said last Monday.
Office values in the City of London financial district experienced their highest fall in at least seven years in July after Britain voted to leave the EU. The referendum result is already forcing landlords to offer longer rent-free periods to attract occupiers and will cause rents in the City of London and docklands to fall 10-12pc over the next two years, according to broker Carter Jonas.
"There has been an increase in tenant space becoming available recently," said Jules Hind, head of leasing and development at broker Farebrother Ltd. "If that trend continues it will have an impact on the wider market where landlords have already increased incentives to secure deals."
Barclays isn't the only bank cutting the amount of space it occupies in London. Citigroup Inc. has offered to rent about 300,000 sq ft (28,000 sq m) in its 25 Canada Square tower to Her Majesty's Revenue & Customs, people familiar with the plan said last month. HSBC Holdings Plc plans to move 1,000 workers to Birmingham, Britain's second biggest city, to cut costs and separate its UK operations.
"Barclays' decision could become a more widespread phenomenon if the UK has a hard Brexit and doesn't retain full rights to passport financial services to the European Union," said Michael Pain, head of the central London unit that advises office tenants at Carter Jonas. "If that is the case, developers will find themselves competing more and more with tenants looking to sublease space."
Commenting on the risk of oversupply in the London office market, UBS Group AG said last August that the build-up of stock had begun long before the Brexit vote had taken place. Warning that this oversupply could not be stopped, Thomas Wels, global head of real estate at the Zurich-based bank's asset-management unit, said in an interview at the time that those properties already under construction would hit the market in 2017 and 2018, and were not priced into rents.
UBS will invest about $3bn in property in European nations other than the UK over the next two to three years as the economy continues to recover, Wels said.
Asian pension funds will target continental European property as they increase allocations to real estate, according to Wels. Japan's top 10 pension funds alone may acquire $200bn of European property over the next decade, he said.
"In Japan, returns are too small and the market isn't big enough to invest domestically," Wels said. "In Europe returns are high, legislation is sound and investors can achieve diversification."
While Jefferies Group LLC analyst Mike Prew says as many as 100,000 jobs could leave London within two years of the UK officially starting a process to leave the EU because they risk losing their passporting rights, Wels doesn't share his view.
Wels, who oversees $77bn of real estate assets in 29 countries for UBS AG, estimates the number of jobs that will move from the UK capital will be closer to 25,000.