The volume of investment into the City of London office market boomed to just over £12bn in 2013. As Graph 9 shows, this is its highest ever level.

The main factor that contributed to this high level of activity was the continuing global risk-averse institutional demand for large property investments. Funds who are coming to Europe looking for prime lots of £200m and above generally have few other choices than to buy in the City of London, and it was two such deals that led to last year's strong activity.

However, even without GIC's £1.7bn purchase of a 50% stake in the Broadgate Estate, and St Martins' similarly large lot size at More London, 2013 would still have seen an investment turnover of £8.6bn. This would have been £2bn over the ten year average for this market.

The continued rise in importance of non-domestic investors to the City and central London investment markets has been well documented, and 2013 saw no end to this trend. 78% of all purchases in the City in 2013 were by non-domestic investors, and this rises to 91% when we look at all purchases of £100m or above.

UK purchasers only accounted for 22% of the acquisitions by volume in the City of London last year, but the actual amount of capital that they deployed in this market rose considerably to £2.7bn in 2013. Indeed, UK investors were the third most active purchasers of lot sizes of £100m and above.

Domestic investors tend to be focusing more on value-add and core plus investments than some of their global peers, though international investors are active even in the most opportunistic markets. Indeed, the competition for development opportunities in the City of London has intensified, with site values pushed up to £300/sq ft in 2013.

So, where are all the sales coming from? While many opportunistic investors have spent the last few years complaining about the lack of distressed selling, the last three years has seen a steady stream of bank or receiver led sales. This trend continued in 2013, with £1.1bn of the sales (12.5% of the market by number of transactions) being bank or receiver-led. While these assets may not be priced as distressed sales, they are still contributing to the availability of product in the City. We expect this trend to continue in 2014.

Another area that stimulated some sales in 2013, and that will continue to do so in 2014, is profit-taking. The City investment market did not go silent during the GFC, and £12bn of assets were transacted in 2008-2010. Many of those investors who purchased City of London office investments over that period are now in a position to realise increases in capital values of 20-30%. While there is no particular cyclical reason to sell out of the City of London in 2014, we do expect to see more profit-taking this year than last.

Yields

Prime City office yields remained stable at 4.75% for the whole of 2013. This is well below the twenty year average of 5.56%, and the ten year average of 5.31%.

This stability in the prime yield has not been mirrored by the recent trend in the IPD average initial and equivalent yields, which have hardened by 15 and 25bps over the last six months. Interestingly the IPD average initial yield for City offices stood at 4.84% at the end of January 2014, only around 10bps higher than our prime yield for the same month.

The market is definitely seeing more emphasis being placed on equivalent rather than initial yields at present. This is a reflection of an increasing acceptance that the rental recovery is not only underway, but that it is likely to be sustained for the foreseeable future.

Outlook

While City yields are lower than their long-term averages, the gap between City and West End prime yields remains at a historically wide level. With the City looking comparatively cheap, as well as being the only market that offers sufficiently large lot sizes to satisfy the global funds, we expect investor demand to be sustained in 2014. There will be more profit-taking, as well as bank-led sales, but we still expect prime yields to harden by 25bps by the end of 2014.

Taken from
Review and Outlook: Central London Offices - February 2014