London’s offices are almost deserted and no one knows how many people will return or when, yet some investors are busy making bets on the capital’s workspace.

“People we haven’t spoken to since the last recession are popping up with pockets full of money saying: we did well last time, what can we get now?,” said Mat Oakley, head of European commercial property research at real estate company Savills.

The question is whether this confidence is well placed or reckless.

The sharp fall in the value of new offices predicted for the pandemic has not yet come to pass. At the same time, sales of office developments have slowed but, where they have happened, prices are at or above pre-Covid levels and competition has been fierce, according to property agents and market data.

“Lots of people are looking for office bargains, but they are not there,” said Oakley.

Shares in London’s largest listed developers, Land Securities, British Land, Helical, Derwent London and Great Portland Estates, have risen between 15 and 30 per cent in the past six months and are approaching pre-pandemic levels.

Those developers are optimistic, insisting their new and well-equipped buildings will remain popular even if employers decide in any number that their staff can work at home.

Some investors seem persuaded, others less so. “Agents and valuers who think nothing has changed have their heads in the sand,” said Zachary Gauge, who leads UBS’s European real estate strategy and research.

According to an adviser to one sovereign wealth fund eyeing the sector: “Half the board are saying ‘no one is going to go back to office’ and the other is saying, ‘so how come prices are rising?’”

Brexit vote put a lid on supply

Vacancy rates in the City of London have risen from 5.3 per cent in March 2020 to 9 per cent in June this year, but the empty space is mostly in older stock and rents in new offices have held firm, according to Savills.

The 2016 Brexit vote slowed down office-building, keeping a lid on new supply coming into the pandemic. Without that, vacancy rates might have been even higher, said William Beardmore-Gray, head of commercial agency and London offices at Knight Frank.

Demand for the best space has also held up: video app TikTok, property company JLL and law firms Travers Smith and Skadden have all committed to large London offices in the past few months.

While retailers and hospitality venues have struggled with rent, office tenants have largely continued to pay, supporting landlords’ cash flows and sparing them the value destruction seen in other types of commercial property.

Lenders to property owners, hoping coronavirus represents a blip rather than a permanent change to the office market, have also been lenient about debt repayments.

But there are considerable risks beneath the surface.

Hybrid working ‘will hit every landlord’

“There is a massive structural shift in Europe [in working patterns]. Whether we are two or three days in the office, it will be a shift. And yet prices are the same or higher. That’s too bullish,” said Gauge. 

Offices in London currently offer more attractive returns than those in European capitals, partly because the Brexit vote cut supply. That might present an opportunity, said Gauge, but UBS would be very selective.

Much will hinge on what level of occupancy workplaces eventually return to.

According to Remit Consulting, London offices were at 11.5 per cent of capacity on average in the week ending August 6. The number of people coming to work each day has hardly changed since the government lifted coronavirus restrictions on July 19 and many businesses have pushed the date for any large-scale return to work far into the autumn.

Because office leases tend to have a 5-15 year term, few companies have yet had a chance to exit their contract. But while some businesses are signing up for new offices, others have already said they will cut space and allow more homeworking. 

In February, HSBC announced plans to reduce its global office space by 40 per cent. Santander has signalled it will shut some satellite offices and a slew of other banks and professional services firms, including JPMorgan, Nationwide, Société Générale, KPMG and PwC have put hybrid working arrangements in place.

Smaller businesses are also changing the way they work. Many are trying to save money by subletting unused space. There is currently 5.6m square feet of space for subletting on the market, almost double the pre-pandemic level, according to Savills. 

The glut of sublet space, which is often offered at a discount, will put pressure on rents in that part of the market. But investors are betting that demand for “prime” offices will remain high even if it falls lower down the market. 

That is one reason that the value of Derwent’s £5.4bn portfolio of high quality offices has started to increase.

Property agents and landlords call this a “bifurcation” of the market and argue that rents for some types of offices can sink without dragging down the rest.

Marina Petroleka, global head of ESG research at Fitch Ratings, doubts this. Hybrid working “will hit every landlord with varying degrees of intensity,” she said.

In a June report, she predicted that the pandemic had created “a structural shift rather than a cyclical or temporary event for the London office market”. 

“If businesses that have been working from home have been able to turnover similar levels of revenue without the office, that’s telling us these offices are not required,” said Euan Gatfield, a co-author of that report.

Investors are on the hunt for returns

The uncertainty does not seem to be holding back investment though and when overseas travel restrictions lift, Asian and US buyers are expected to target London.

According to Oakley, investment decisions are being “driven by the weight of money rather than any improvement in [investors’] perception of market fundamentals”. With bond yields and interest rates so low, a 4 per cent yield on a London office looks attractive. 

But lack of demand, the high costs of upgrading buildings to meet stricter environmental standards or falling rents could quickly wipe out that income.

“Current market conditions seem in many ways to be disconnected to the number of risks that are bubbling under the surface . . . we’re not going back to the old days,” said Gatfield.