Sink or swim: The big story of 2007 was the credit crunch triggered by the US sub-prime mortgage scandal. Nadia Elghamry looks at how the world’s financial markets have been affected
Wave after wave of bad news has buffeted global markets. Rogue traders, white-knuckle rides on the stock market and sliding house prices, coupled with plummeting consumer confidence, have all taken their toll. In London, capital values have slumped as investors shy away from the market.
With the US expected to release more dismal news about its economy in the second half of the year, and the first jitters seen on the Asian stock markets, EG looks at how investment markets in financial centres across the globe are faring.
London
There has been some grim reading for London’s investors. The FTSE has become a four-letter word, a string of insurers have slammed their doors on those trying to rescue their money from commercial property funds, and rising inflation has made large-scale interest rate cuts unlikely.
All this may have soured the view that a short, sharp correction dealt to the market at the end of last year would be enough to put a floor under falling capital values.
But some agents remain optimistic, and are keen to point to high-profile deals – such as at Condor House, EC4, which boosted sentiment when it sold for a hefty £115m in December. However, the fact that its quoting price was £130m has gone unremarked.
This is bad news for UK funds, which have £600m of stock on the market to sell.
In some ways, the fall was long anticipated. Stephen Hubbard, deputy chairman at CB Richard Ellis, believes that a return to the more sensible levels of 2005 was always on the cards.
Looking forward, as investors sit it out, Hubbard says that the second quarter will be slower than normal. “There are deals being agreed at a 5% reduction to December valuation,” he says. “We’ve had a massive repricing in New York and London. Prime yields have probably moved out as far as they are going to, but grade-B stock is still finding a level.”
Any talk of a recovery now depends on how the occupier markets react. In the City, there has been a definite slowdown among US-led organisations. “They tend to draw their claws in around Europe when the home markets are looking shaky,” says Hubbard.
The problem is that last year’s figures still weigh heavily on the market. Excluding the two massive deals in Canary Wharf – Citigroup’s £1bn sale to Quinlan, and Propinvest’s and HSBC’s £1.09bn sale in December – the City suffered its worst performance for more than seven years, according to Jones Lang LaSalle.
The West End’s market fared better, says Savills, but in Q4 of 2007, £1.5bn was traded in 42 deals – compared to £2.7bn in 83 deals for the same quarter in 2006.
Paul Cockburn, head of Savills central London investment, puts it bluntly when he says: “To say that new buyers were feeling reluctant to buy in Q4 2007 is an understatement.”
He adds that cash-rich buyers are, at best, exercising extreme caution. “Most are sitting on the sidelines window-shopping,” he says, “occasionally making a cheeky bid.”
Cockburn stops some way short of predicting an all-out crash, saying: “There is simply too much money around, and already the vultures are circling.” He points to Park House on Stratton Street, W1, bought one year ago for a yield of 4.25% by Standard Life and sold recently to Arab Investments for 5.2%.
These cash-rich buyers are key, and already agents report that Irish investors want to get back into the market.
James Crawford, head of City investment at Savills, says: “UK funds are generally worried, having acquired significant City holdings at the peak of the market. Many are now selling and taking a hit. The Irish, however, are still very active, and were the most active investor group in December 2007.”
Indeed, total Irish transactions in 2007 held steady through the eye of the credit-crunch storm, registering £248.7m in Q3 and £253.9m in Q4.
Other international investors may also now dip their toes back into the cooled investment waters.
Julian Stocks, head of UK Capital markets at JLL, points to slack yields as a source of optimism. “The Germans will look at buildings around the 5.5% mark, and they can get good buildings in the City for that, now,” he says. “I’m not sure we are at the bottom yet – it is a little too early to be talking about opportunity cash, but we’ll see by Q2 that deals are being done again.”
His colleague Ross Davies, director in City investment, says: “The bigger lots, around £100m, are still in a bit of trouble. And what people were calling ‘angles’ on buildings are starting to be called ‘problems’ again. We are seeing in due diligence that things are being interrogated to the nth degree – it is a much more normal market.”
That will be some comfort for developers with schemes on the ground and hoping to make a quick exit. Between now and 2010, around 3.9m sq ft will complete in the West End and 5.4m sq ft in the City. Most schemes are already under construction, says Mat Oakley, head of commercial research at Savills. “Beyond 2010,” he adds, “there is opportunity to delay the start, and I expect developers will look closely at the evolution of supply and demand balance this year.”
New York
While London agents believe that the worst is over, New York investors think the worst may be yet to come. JLL is predicting a national decline in investment volumes of about 35-40% this year. New York’s could drop by 25-50%.
These figures are coming off a serious high. In 2007, Savills estimates that sales volumes of $515.1bn were nearly double those of 2006. “These sales mark the end of a five-year bull run,” says John Lyons, head of Savills Granite in the US.
He says that prices are holding up in New York across all sectors, but those in Chicago and Washington DC are not. “Many buyers believe in property fundamentals but have been blindsided by the current debt market distress,” he explains.
The result? Dramatically higher debt costs and reduced funding.
Private investors, who had dominated the buying market, are currently in a “holding pattern”, says Lyons. As a result, the tables have turned and larger institutional buyers, which had been sitting out of the latest buying frenzy, are now beginning to take advantage of the slower pace and make larger purchases. For example, institutional buyers bought nearly half of all the properties sold in New York in Q4, with a focus on offices.
REITs have yet to take advantage of the buyers’ market, says Lyons, although he predicts that they will become more active this year.
Jittery capital markets have taken their toll on lot sizes. Commercial mortgage-backed securities facilities had allowed smaller investors to leverage up and buy larger assets – Lyons points to Macklowe’s $7bn acquisition of the Equity Office Properties portfolio, which used just $50m in cash equity in February last year. Macklowe has since been back to the marketplace to refinance debt.
“The ability for all investors to purchase large deals is no longer there. Smaller deals are easier for cash-hungry, low-leverage investors to digest at this time,” says Lyons.
Developers are being similarly cautious, he adds, preferring to work on land banking so that they are ready to build as the markets change.
Smaller, less well-established developers are finding it difficult to finance new projects and, Lyons says: “Investors are also looking for distressed development deals which may require a ‘white knight’ rescue.”
Shanghai
If markets are truly global these days, then Shanghai investors do not seem to have noticed. Investment rose by a healthy 12% in 2007, and Grant Yabsley, head of North Asia transactions, Asia Capital markets, at JLL, says that investor confidence remains high. “Participants are becoming more comfortable with the investment risks as their home markets falter and the US dollar weakens,” he says. “As a result, they are increasing allocations, not only to China but to the rest of Asia as well.”
Yabsley believes that 2008 will be a defining year for Shanghai’s grade-A office markets. He points to steadily rising rents in Puxi district and competition from new buildings in Pudong. Vacancy rates are low, at 1.6%, but this will be tested this year as 845,000m2 of grade-A office space – 2.5 times the historical average – enters the market.
According to Savills, in 2007 there were eight deals worth more than US$30m, totalling $1.2bn. However, new regulations could cause a hiccup. James Macdonald, in Savills China research department, points to new rules on foreign investment called Circular 130, which limit the use of foreign debt in acquiring properties. This has been blamed for a slowdown in Q4 figures.
Hong Kong
Negative real interest rates have caused a surge in activity in Hong Kong’s investment market, says JLL’s Grant Yabsley.
Grade-A office vacancy rates have plummeted, reaching 1.6% in central areas, against 4.2% in December 2006. This, coupled with Hong Kong government initiatives to promote economic development through infrastructure projects and large-scale developments, such as West Kowloon Cultural District and Kai Tak Development, has led developers to turn on the construction tap.
During the next four years, Yabsley says, there will be a total net increase of 936,000m2 of office space. However, he warns that the completion of 418,000m2 of space in 2008 may cause rents to slump.
The investment market is dominated by local investors, but overseas investors, such as listed REITs, and private investors from Australia, China and Indonesia, are also becoming key.
Yabsley predicts that interest from US and European investors, including Morgan Stanley, Citigroup and ING Real Estate, will accelerate as they seek out the faster returns on offer in Asia.
Frankfurt
German investors have taken their New Year resolutions to a new level. Commentators report a high degree of “abstinence” in the marketplace, and highly leveraged investors have disappeared off the Frankfurt investment scene.
Foreign investors are expected to follow suit, and Savills predicts that investment volumes will halve from €8bn in 2007 to €3bn-€4bn by the end of the year.
Admittedly, 2007 was shaped by several trophy asset sales worth more than €500m, but the figure is still below the €5bn achieved in 2006.
Thomas Schweder, director at Savills’ Frankfurt office, is expecting trust to return to the market in the next six months. At present, developers are still taking risks, with little let-up in the delivery of space in the next three years. Large increases in rents are expected to compensate for reduced capital values.
Vacancy rates are decreasing, from 16.2% in 2006 to 13.7% by the end of last year, and vacancy among top quality space in the CBD is much lower, says Helge Scheunemann, head of research, Germany, at JLL.
But Frankfurt, Germany’s main financial centre, could be hard-hit by a recession. Scheunemann says: “We’ve noticed a slight reduction in enquiries from banks and financial companies in the last quarter, which could lead to lower take-up at the start of 2008.”
