Oversupply of buildings is biggest risk to London office market

The wave of office buildings under construction in London is a bigger threat to rents and values than the risk of companies moving out after the UK’s vote to leave the EU, according to UBS Group.

“We saw a build-up of oversupply of office space long before Brexit which can’t be stopped,” Thomas Wels, global head of real estate at the Zurich-based bank’s asset-management unit, said.

The additional space “will hit the market in 2017 and 2018 and isn’t priced into rents,” he said.

Developers tried to capitalise on rising rents by starting work on a record number of central London office projects in the six months through March.

Values may decline as much as 20% there as companies consider moving some operations to continental Europe or delay expansion plans following the vote, according to Green Street Advisors.

International businesses could shift as many as 100,000 jobs away from London within two years of the UK officially starting a process to leave the EU because they risk losing their passporting rights, Jefferies Group analyst Mike Prew said in June.

Mr Wels, who oversees $77bn (€69.4bn) of real estate assets in 29 countries, estimates the number of jobs that move will be closer to 25,000.

UK commercial-property values probably had their steepest decline since December 2008 in July following the vote for Brexit, Osmaan Malik, a London-based analyst at UBS, wrote last week.

Office prices fell 6.1% in the City of London financial district in July on heightened economic uncertainty, especially for financial-services firms, broker CBRE has said.

Construction began on 51 office buildings in central London in the six months through March and the amount of space being developed almost doubled in 18 months.

UBS will invest about $3bn in property in European nations other than the UK over the next two to three years as the economy continues to recover, Mr Wels said. Economic growth in the eurozone will reach 1.6% this year, compared with 0.3% in Japan, the IMF forecasts.

Asian pension funds will target continental European property as they increase allocations to real estate, according to Mr Wels. Japan’s top-ten pension funds alone may acquire $200bn of European property over the next decade, he said.

“In Japan, returns are too small and the market isn’t big enough to invest domestically,” Mr Wels said. “In Europe returns are high, legislation is sound and investors can achieve diversification.” Mr Wels favours investing in multifamily properties, stores and offices in Spain, Italy and Germany, he said.

“Outside of Germany and the Netherlands, which already have mature rental markets, residential will be the thing of the future,” he said.