Is London’s office bounce back under threat?

At the beginning of this year, investors in office assets and developers were cautiously optimistic. Concerns around the post-pandemic work-from-home revolution were receding, while interest rates appeared to be on a downward trajectory. In London, with a shortage of high-quality office stock and resurgent demand, rents have reached over £100 per sq ft, a rate unheard of not long ago. But, with the outbreak of war in the Middle East and interest rates predicted to rise, could the capital’s recovery in the prime office space market be at risk? 

Real estate developer share prices have taken a hit due to their sensitivity to interest rates. This is not so much about current interest rates as about their perceived direction of travel, with some of the more pessimistic commentators conjuring the oil-price-shock-induced stagflation of the 70s. Analysts are forecasting no base rate cuts this year from the Bank of England, with some analysts even expecting up to a quarter of a point rise by the end of the year.  

Of course, for real estate developers, higher interest rates mean development finance becomes more expensive, and rising base rates require higher yields for commercial real estate to compete with other asset classes for investment capital. This is on top of rising inflation and its impact on construction costs. All undermine the project investment case’s foundations.  

For commercial real estate developers, the crucial question is how long the war continues and the extent of its dreadful impact. This will dictate the trajectory of inflation and interest rates.  

Currently, the market fundamentals for London offices are good. There is a shortage of Grade A office stock - the slick, energy-efficient buildings with amenities such as cafes and fitness studios, which are in demand from the tech, finance and professional service occupiers and their skilled workforce. This is a result of a construction supply squeeze, a legacy of the economic turmoil of the pandemic and the outbreak of war in Ukraine. Demand has picked up, with some firms even reversing plans to downsize their office footprint. Recently, US banking giant JP Morgan, showing its belief in London, decided to build a new £3bn headquarters and London’s largest office building at Riverside South in Canary Wharf.  

Although far from the positive forecast for developers and investors, the outcome of the war in the Middle East is unlikely to be a repeat of the shocks of the pandemic and war in Ukraine.  

Amidst the gloom, London could even benefit from its safe haven status, with international capital reevaluating the risk of investing in competing financial hubs such as Dubai. 

With central London’s shortage of high-quality offices and strong demand, developers should not abandon their plans. Confidence will be the key commodity. And, of course, this will need to be sown into communication plans.