London developers target old offices at risk of becoming stranded assets

London’s property developers are preparing to pounce on cheap old office blocks whose current owners face a choice between investing heavily in environmental upgrades, selling at a discount or risking their buildings becoming stranded assets.

Last month, the FTSE 250-listed serviced office company Workspace paid £45m for The Busworks, a 19th century bus factory that had been converted into a business centre.

The seller had owned the building for four decades but could not swallow the £15m-£20m costs needed to bring it up to the standards required for a modern office, according to Graham Clemett, Workspace’s chief executive.

Faced with more exacting tenant demands, tighter emissions standards and the pandemic, a growing number of small-scale office owners are expected to sell up, creating an opportunity for well-capitalised investors to snap up dilapidated buildings at a discount.

“Debt providers are not lending against ‘brown’ buildings unless there’s a viable plan to upgrade them to green status . . . there’s a lot of money to be made by people who can buy the stranded asset and upgrade it,” said Mike Prew, an analyst at Jefferies.

Specialist developers including Workspace, Great Portland Estates — recently rebranded as GPE — Derwent London and Helical have all signalled that they will target old, tired buildings to refurbish.

Regulations on the energy performance of buildings are tightening from 2023 and currently only one in 10 London offices meet the standards that will be imposed from 2030, according to Savills. Pressure is also building on developers to refurbish existing stock rather than build new, which is a far more carbon intensive process.

Swiss bank UBS estimates that it would cost between £150-£200 per sq ft to refurbish a central London office to the highest standards, equivalent to roughly two years of rent on the best stock.

“In the past one might have done a coat of paint and a new carpet. In our view you have to do slightly more than that now. In buildings which are 15-20 years old, the plant will need replacing, the internal building will be pretty worn out. One is talking of substantial refurbishment to get it up to standard,” said Gerald Kaye, chief executive of London-focused developer Helical.

The pandemic has added to the burden for the owners of older buildings, many of which are small landlords, family offices or individual investors. London’s offices are currently only about 20 per cent full and older buildings have seen vacancy rates rise fastest and rents fall furthest as a result of coronavirus.

Falling occupation and rising costs have left a large swath of London’s office market at risk of becoming stuck in the hands of owners lacking the funds to upgrade them.

Those buildings will have to be demolished, converted into new uses such as housing or refurbished, said Isabelle Scemama, global head of Axa IM Alts, one of Europe’s largest real estate investors. “In the end we will have no other option other than to transition those assets into something more efficient. The price will have to adjust for those stranded assets,” she said.

“Regulations will force everyone in the end to transition. If your buildings don’t reach a certain level of [energy performance] you will have no revenue and no liquidity.”

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