Landsec swings to loss as London office valuations drop

One of the UK’s top landlords has swung to a loss after an almost 10 per cent drop in the value of its City of London offices, in an early sign that higher interest rates could trigger a widespread commercial property downturn.

Landsec on Tuesday reported a pre-tax loss of £192mn for the six months to the end of September, compared with a £275mn profit in the same period last year, as the valuation of its portfolio of national offices and shops fell 2.9 per cent to £10.9bn.

The steepest falls were on the FTSE 100 landlord’s nearly £2bn portfolio of City of London offices, which lost 9.7 per cent of their value in the period.

Mark Allan, chief executive, said rising borrowing costs had changed the outlook for the sector.

“The material increase in bond yields since March has started to put upward pressure on property yields, principally for those assets where yields were lowest,” he said. “In the sectors we are in, this principally affected London offices.”

Interest rates have been rising since late last year, when the Bank of England moved the benchmark rate up from historic lows.

A higher base rate has increased the cost of borrowing and made commercial property less attractive to institutional investors that can now hold bonds with a similar yield but lower risk than offices or shops. The result has been to push up property yields — which move inversely to prices.

Allan added that the outlook was increasingly challenging.

“Decades of globalisation, fuelling growth and depressing inflation, have started to go into reverse, with rising geopolitical tensions adding to risks around energy reliance and supply chains,” he said.

Colm Lauder, an analyst at Goodbody, said Landsec’s results had given an early taste of what is to come for commercial property owners.

“The pain that is coming through in the second half [of the year] is going to be significantly worse,” he said. “The market has moved on so much since September.”

The “mini” Budget put forward by former chancellor Kwasi Kwarteng on September 23 and eventually dismantled by his successor Jeremy Hunt accelerated an increase in property yields, as investors started pricing in higher risk and expectations of further interest rate rises.

With the measures in that Budget now rejected and the market pricing in more moderate inflation and a less severe increase in borrowing costs than previously feared, the company’s share price has risen by almost 20 per cent in the past month.

Nonetheless, underlying property values are likely to continue falling.

Lauder estimated that yields for prime commercial property assets such as high-grade London offices or urban warehouses could move to 5 per cent, from a starting point earlier this year of close to 3 per cent — implying much more significant drops in valuation than those revealed so far.

Landsec is also contending with relatively high office vacancy rates of 12.2 per cent in the City of London, as businesses consider their post-Covid workplace needs.