Derwent London Shares Downgraded as Rental Growth Expectations Decline

Derwent London shares (LON:DLN) are facing headwinds after JPMorgan downgraded the stock to Neutral, signalling a shift in market sentiment regarding the real estate investment trust's near-term prospects. The downgrade reflects concerns about moderating rental growth in the central London office market, a key driver of Derwent London's performance.

The JPMorgan downgrade set a price target of 2,100 GBp, a decrease from the previous 2,400 GBp. This adjustment aligns with a broader trend of reassessment among analysts. Year-to-date, the stock has already declined by approximately -14.22%, indicating existing market apprehension. The downgrade compounds this pressure, suggesting further volatility.

JPMorgan continues to recognize Derwent's robust investment portfolio, high-quality development pipeline, and strong balance sheet. However, the firm now anticipates diminished rental growth potential in the near term. This aligns with a similar sentiment expressed by UBS earlier in November, which downgraded Derwent London to ‘Sell' with a price target of 1,700 GBp, down from 2,420 GBp.

UBS cited concerns over slowing rental growth and challenges in achieving returns above the cost of capital amid a high-interest-rate environment. They project West End office rental growth would moderate from over 5% to just under 2% by 2028, influenced by increased office supply, softening job growth, and the potential impact of AI on entry-level roles.

This cautious outlook contrasts with Citi Research's upgrade in January 2025, which rated Derwent London a ‘Buy,' setting a price target of £27.67. Citi's optimism was rooted in the perceived undervaluation of the stock and resilient rental dynamics in the prime London office market. Citi highlighted a significant supply-demand imbalance, particularly for Grade A office space, estimating potential rent growth of 30% to 50% as tenants upgrade to higher-quality offices.

Derwent London's H1 2025 results revealed flat earnings, with EPRA net tangible assets per share rising 1% to 3,187 pence, falling short of analyst expectations. While the company maintained its rental growth guidance, higher vacancy rates contributed to the mixed results. Gross rental income saw a modest 1.5% increase to £109.1 million, with open-market lettings averaging 10.5% to 11% above estimated rental value. The interim dividend was increased by 2% to 25.5 pence.

Despite the downgrades, Derwent London has reported positive leasing activity, with £13.8 million in new leases and renewals. Open-market lettings remained above estimated rental value, and the company has maintained a low vacancy rate. Furthermore, the stabilization of property values, with a 0.2% portfolio growth over the 12 months, and an upgraded 2024 rental guidance to a range of 3% to 6%, suggest underlying strength in the company's operations.

The divergence in analyst opinions reflects the complex dynamics of the central London office market. Factors such as interest rate fluctuations, evolving demand for office space, and macroeconomic uncertainties contribute to the varying outlooks. The market is currently weighing the balance between resilient leasing activity and potential headwinds from slowing rental growth.