A series of sales in which lenders are facing painful losses is laying bare the extent of the correction roiling parts of London’s office market.

Canary Wharf’s 5 Churchill Place, a 12-storey office block that was seized by lenders earlier this year, is being sold to claw back money on defaulted debts. Some bids for the property, which is being sold on behalf of its lenders, are so low that they work out to less than the amount of rent still owed by tenant JPMorgan, according to people familiar with the situation. 

That effectively ascribes a negative value to the building and the land on which it sits – reflecting the vast sums that would need to be invested to give the building a viable future, said the people, who asked not to be identified as the process is private. 

While an extreme example the travails of 5 Churchill Place, a 14-year-old block originally built for Bear Stearns before it was subsumed into JPMorgan, illustrates a trend that’s becoming increasingly apparent. While newer or recently refurbished buildings have been able to attract interest, older buildings outside the best areas or with low environmental ratings are struggling to draw tenants. 

The post-pandemic surge in hybrid working combined with an abrupt increase in the cost of finance have battered London’s office market. In some cases, this has led to collapses in value so big that they’re creating credit losses for even relatively conservative lenders. 

“The erosion in value we are seeing for older, second-hand office stock that does not meet environmental standards means that credit losses are becoming a real risk,” said Chris Brett, CBRE Group’s head of capital markets for EMEA.

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Secured lenders to 5 Churchill Place, which was owned by China’s Cheung Kei property developer and financed by Lloyds Banking Group, are owed about £196 million (S$329.5 million). The building has more than 10 years left on its lease and generates an annual rent of over £13 million.

But the cost of re-purposing the building – and the eventual likelihood of finding tenants – remain highly uncertain, leading some bidders to offer less than £130 million, the amount of rent that the buyer would eventually be owed. 

A similar calculus is troubling the Bank of Ireland, which is attempting to sell a loan secured against the One Poultry office block in the City of London district. While that building’s location above the Bank tube station is highly desirable, the property needs substantial work if it is to appeal to choosier post-pandemic renters.

“Unsurprisingly, we are seeing increased restructuring activity relating to offices,” said Mark Addley, a partner and real estate restructuring lead at PwC. “Whilst debt financing to the office sector post the global financial crisis has generally been conservative, you need to look at each office on its own individual merit.”

The Bank of Ireland’s decision to sell the loan came after a plunge in the property’s valuation and a series of failed attempts to sell or refinance the building. Still, recent bids have been below even the discounted price that the bank is asking for, said people familiar with that process. These are signs of a broader turnaround.

For years, investors from Canada to Korea were drawn to London’s office buildings as a source of stable, long-term income whose returns beat out those of bonds. But more recently, a confluence of factors – radical shifts in working practices, demand for more sustainable buildings and the sudden end of the zero-interest rate era – have upended these bets.

“This isn’t the global financial crisis, but in some ways aspects of this are more challenging because you have this repricing going on against a backdrop of huge structural change as well,” said Ben Sanderson, managing director for real estate at Aviva Investors. “Some of these problems are not fixable. The problem is fundamental uncertainty about office occupational demand.”

Developers are typically the first victims of downturns as lengthy projects can be knocked off-course by sudden shifts in construction and financing costs, tenant demand and fluctuations in sales prices between start and completion.

South of the River Thames, for instance, Fabrix London Limited purchased a site for around £64 million in February 2020, just weeks before the coronavirus pandemic sent much of the world into lockdown. After the pandemic, builders were preparing to break ground on the ambitious “Roots in the Sky” development, which was to see a former criminal court kitted out with a rooftop forest, bar and pool to tempt workers back to the office. 

Yet the London office market – and the way people work – is now too radically different. The lenders, an entity controlled by the billionaire Reuben brothers, have appointed a receiver to the asset. 

“It is a relatively rare phenomenon that values are dropping at the same time that construction and finance costs are rising,” said Cheyne Capital head of UK investment Arron Taggart. “This has led to residual values reducing in some cases by 50 per cent or more. Even lending on a conservative basis can mean that there will be some losses.”

At The Stage, a mixed-use development that counted bankrupt WeWork as a key tenant, a consortium led by Cain International is in talks about injecting more equity into the building to help secure a refinancing, said people with knowledge of the process. Amazon.com is set to lease the vacant office space, easing the negotiations with lenders. A spokesman for Cain declined to comment. 

Even for investors without immediate pressure to refinance, the current realities of the market can be brutal.

Senator, an office development partially leased to wealth manager Quilter, was first put on the market in 2021 with an asking price of £157 million. But the seller, Legal & General Group’s investment management unit, has so far only attracted bids for less than half that amount, according to two people familiar with the situation who asked not to be identified as the process is private. A spokesperson for L&G declined to comment. 

Similarly, Blackstone is in the process of selling Cargo, the former Financial Conduct Authority headquarters in Canary Wharf that now houses BP’s oil traders. While the private equity firm is nearing a deal, the price is well short of its original aspirations, people with knowledge of that process said. A spokesperson for Blackstone declined to comment.

With the exception of Cargo, none of these buildings would classify as so-called prime real estate, the difficulty in setting up sales suggest that more pain is to come. In November, Land Securities Group revealed it had marked down the value of its City of London portfolio by 9.3 per cent in the six months through September. 

Rival British Land, which has also booked sharp write-downs, cited the fact that its portfolio is now valued at a 6.1 per cent yield, a significant premium to the five-year swap rate, as evidence that prices may be near their bottom. While that’s true, the spread between UK property yields and swap rates is tighter than it has been in recent history. 

Buildings with loan maturities approaching are also adding to borrowers and lenders’ anxieties. 

Brookfield has been forced to restructure the terms of a loan backed by Citypoint, a London office first built as the corporate headquarters of BP in the 1960s, giving it another year to sell the building or refinance the debt, according to a statement on Wednesday. 

The loan was already extended twice as the building’s value fell and was due for final maturity next month, but Brookfield was granted more time in exchange for a one-off fee and increased margin for lenders. The debt against the building was securitised into a commercial mortgage-backed security, while Mirae Asset Securities and Inmark Asset Management provided mezzanine financing, deal documents show. BLOOMBERG