The news of the death of the London offices is greatly exaggerated. At least that’s what KKR thinks. In order for your newly acquired 5% in Great Portland Estates real estate to be profitable, the changes caused by the virus will have to be reversed. The exodus from London offices is in its second wave. Nearly half of employees work from home every day, compared to just a quarter on the continent, according to Morgan Stanley. And although banks like JP Morgan have asked their staff to return to the office, a spike in infections has slowed it down. Shares of London office owners are down 30% since January. Hence KKR’s opportunistic interest in Great Portland Estates, and the recent increase in Brookfield’s stake in British Land.
The KKR movement has two problems. One is that taking small stakes like this is not why your partners pay handsome management fees. The other is that Great Portland Estates only collected 74% of its office rents in June, up from 100% in 2019. A more pessimistic view is reflected in the implied yield. In March, their rents gave a return of 4.5%. Before Monday’s big rise, the stock was trading 36% off the NAV, implying a return of more than 6%. Since returns go up when property values go down, it indicates that investors may be expecting a collapse in rents.
Great Portland can cope with unpaid rents and empty offices better than most. It has relatively low leverage and, unlike British Land and Land Securities, limited exposure to retail assets. It also has considerable room for maneuver. Asset prices are expected to plunge 68%, twice what the market expects, before debt pacts are breached.
They could all be right: enough workers could come back so that the drop in rents isn’t too painful. But given the scope for telecommuting to last, KKR takes a fair amount of risk.