London office stocks to benefit from higher oil price, says Morgan Stanley

Morgan Stanley says the recent rise in oil could be a positive for London-focused office property groups, as it looked into the historic correlations between real estate and commodity prices.

In a research note on Monday, the bank reiterated its 'overweight' recommendation for both Derwent London (2,700p target price) and Great Portland Estates (545p target price).

The bank explained that prime real estate is typically used as a "store of value" for wealth that's been derived from commodities – ie Middle Eastern sovereign wealth funds – so it makes sense that higher oil prices should lead to higher demand for prime real estate. And over the past three months, oil has jumped by around 30% from $70 to $90 a barrel, as global oil inventories continue to decline.

"There are clearly other more fundamental factors at work driving real estate capital values (rental demand, future supply, cost of capital etc) and we also note that this positive correlation may not apply for all real estate; for retail assets for example, oil price inflation may be a drag on retail spending that feeds through to retail sales, and therefore to tenant affordability," Morgan Stanley said.

"But [...] prime London office values priced in barrels of oil suggests material upside potential for London office stocks on a 12-month view, all else equal."

For Derwent London and Great Portland Estates, the bank said their balance sheets are "sufficiently capitalised" while net asset value valuations are close to or at all-time lows.

"We are alive to the fact that broader UK exposure and offices as a sub-sector are out of favour, but at current valuation the risk reward is compelling, in our view. A higher oil price provides - even if only incremental - an improved risk reward by potentially limiting some downside risk, all else equal."