Refurbish to Reinvent identifies a looming shortage of quality office space in a number of UK regional office markets and predicts the rise in popularity of secondhand office space for both occupiers and landlords.
From an occupier perspective, choosing a refurbished office provides the benefits of a new high quality office at a lower cost and in a shorter time frame, in contrast to a new redevelopment. It may well be the most pragmatic, savvy, cost effective option, particularly if existing office space is centrally located, possibly benefitting from an attractive car parking ratio (something which is less common in new built stock). There are also key environmental benefits, including the option to attain higher sustainability standards.
From the landlord perspective, there is clear opportunity in repurposing existing office space, particularly in rising markets where prime space is limited or is slow to trickle through into availability. Elsewhere, in locations that have seen substantive amounts of office space lost to other uses, repurposing allows the creation of office space that stands out from other secondary space in the market, thereby maximising income.
For Q3 2016 originations, Senior CRE lending returns are forecast to be 3.1%pa on a gross basis and 2.8%pa on a risk-adjusted basis. This represents no change on Q2 returns.
The previous quarter’s estimated 25bps rise in margins reflected weakening sentiment in the final week of June after the Brexit vote. That senior margins have been flat over Q3 2016 reflects in many ways a quicker return to “normality” than was thought likely three months ago.
There was only a very slight fall in 5yr swap rates of 6bps over the third quarter.
A modest improvement in the forecast for capital growth resulted in a very slight decline in Probability of Default and Expected Loss over the third quarter.
The key measure for banks, Return on RWA (calculated here as a function of margin and fee alone), was largely flat. On an RoRWA basis, gross returns were 3.5%pa and risk-adjusted returns 2.9%pa, assuming Strong slotting treatment.
Senior CRE lending continues to offer a healthy premium of 2.5%pa to the risk-free rate, on a risk adjusted basis.
Against corporate debt, the relative return offered by senior CRE debt improved further over Q3 to 1.8%, the highest level for almost two years. Spreads on CMBS narrowed a little, making senior CRE lending look slightly more attractive versus this asset class than three months ago.
On a risk-adjusted basis, CRE debt arguably offers significantly more attractive returns than ungeared equity. This is particularly true of some key segments, including London offices.
Our first post referendum vote release of yields is set out below.
• Immediately after the vote, the sector was marked out as one that would be comparatively robust. Whilst values have slipped in most commercial markets over the last 3 months, the residential investment sector seems to be holding its own, albeit with lower levels of activity and some weakening in secondary markets.
• Manchester continues to appeal to investors with LaSalle announcing its acquisition of Greengate, M&G forward funding its first scheme in the region at Port Street plus Glenbrook/Moorfield and Delph also making acquisitions.
• Other headline activity saw the Europa Capital & Addington Capital Joint Venture acquire Velocity Village in Sheffield and L&Q forward fund a scheme in Acton.
• The possibility remains of potential deal renegotiations pushing yields outwards in secondary locations over the next 3 months.