From the beginning of the year, the City of London investment market has witnessed a burst of activity from both buyers and sellers. The total volume of deals for the first half of the year has reached £3.3bn (€4.3bn), including assets under offer, according to Gresham Down Capital Partners.
While transactions are significantly down from the volumes traded from 2005-2007, they represent a marked increase from the first halves of 2008 and 2009, during which the yearly totals were around £4.5bn. During the second quarter of 2010, £1.1bn worth of property changed hands in the City in 22 deals, with a further £1.1bn under offer, according to Cushman & Wakefield.
An imbalance between the demand for and supply of good-quality investment opportunities has resulted in a sharp fall in yields in the Square Mile over recent months. Prime yields have hardened from around 7% at the nadir of the market in 2008 to their current level of 5.25%, a level at which they look set to remain for the short term at least, owing to continued investor appetite for prime assets. The yields are underpinned by rising rents as the availability of Grade A space is set to decrease.
“In most instances, the investors are seeking good-quality, medium to longer-term income opportunities with little or no exposure to risk,” says Colin Wilson, head of central London investment at DTZ. “That said, an increasing number of more sophisticated investors, in particular those that have been active in the City for a number of years, are considering higher-risk opportunities, even speculative development.
“This can be attributed to two factors. First is the rapid compression of yields that has taken place over the past 12 months. And second is a growing belief in the return of strong rental growth for the main sub-markets of central London.”
The City has seen a number of trophy assets sold during the second quarter, and more are expected to sell in the coming months. In June, Middle Eastern investor AGC Equity Partners bought the 201,000 sq ft (18,700 m2) Milton Gate, EC2, from Evans Randall for £164m, reflecting a yield of 6%. Evans Randall also sold its 110,000 sq ft Condor House, EC4, to European investment firm SEB for £110.4m – a 5.29% yield. Turning buyer, Evans Randall bought the 292,000 sq ft Drapers Gardens, EC2, for £240m – a 5.1% yield.
More recently Mitsubishi Estate Company and Mitsubishi Corporation have sold their 160,000 sq ft Bow Bells House, EC4, to a private investor client of Constanti Real Estate and Gresham Down for better than the asking price of £140m – a yield of 5.8%.
Also in July, Hermes and BlackRock agreed to sell their 400,000 sq ft Tower 42, EC2, to Chinese Estates for around £300m. German fund manager Union Investment Real Estate has also agreed to sell its 260,000 sq ft 10 Gresham Street, EC2, to a joint venture between Hammerson and Canadian Pension Plan Investment Board – the same syndicate that bought the Silverburn shopping centre, near Glasgow, for £297m in December. Hammerson will pay £175m – a 5.75% yield – for the Gresham Street asset.
“Assets which continue to attract most interest are either prime properties let on long leases of 10 years-plus, which overseas investors are most competitive on, or well located secondary properties that offer active management or refurbishment/redevelopment potential, which generally are purchased by a combination of UK investors and European and North American opportunity funds,” says Robert Buchele, a director at Gresham Down. “There is an increasing amount of interest from Middle Eastern and Far Eastern investors, but most of these are targeting large trophy assets.”
The breadth and depth of international capital remains eclectic, as investors from a wide range of countries, with a wide range of strategies, show interest. The City has retained its attractiveness given the high levels of liquidity, the relative ease of entry into the market and the overall stability in the property market and wider economy. DTZ estimates that around 65% of transactions were accounted for by overseas investors, compared to 76% during the fourth quarter of 2009.
According to Bill Tyser, a partner at Cushman & Wakefield, UK institutional funds were involved in 21% of second-quarter 2009 transactions, while UK property companies were involved in 18%. The main sellers have been international funds, largely led by German funds, which accounted for 62% of the sales.
It was widely felt that investor interest in the City market would begin to wane as a result of the General Election and the austerity measures announced in the recent emergency Budget, not to mention the Greek sovereign debt saga. But the Square Mile remains a priority investment destination, especially for overseas investors, owing to the long leases available on prime buildings.
Prime rents expected to rise
There is also widespread belief that prime office rents will continue to rise over the next two or three years. This belief is partly the result of the lack of new development activity. The expected rise in rents should deliver future performance both on an income and capital basis.
“Following a period of uncertainty in the run up to the election and emergency Budget, the market appears to have settled again, although the shortage of stock means the summer period is likely to be a quiet one in terms of new deals,” says Nick Braybrook, City investment partner at Knight Frank.
Following an explosive first quarter, the City’s occupational market has not fared quite so well in the three months to the end of June. Take-up during the second quarter was 983,000 sq ft – more than 50% lower than the previous quarter, according to CB Richard Ellis. However, take-up was 41% up on the same period last year. The banking and finance sector were again the key drivers of demand, accounting for 46% of take-up during the second quarter.
The amount of available Grade A space in the City is still high – 3.5m sq ft is available, compared to a long-term average of 2.4m sq ft, according to DTZ. But delivery of Grade A space in 2011 will total just 1.1m sq ft, and buildings offering more than 100,000 sq ft of Grade A space (of which there are only seven in the City and a further two in Docklands) will be supplemented by only three buildings of this size by the end of 2011: the Heron Tower, EC2; Cannon Place, EC4; and the refurbished 2 Waterhouse Square, EC1.
This dearth of new-build has also affected incentives packages offered, with occupiers on Grade A space typically being offered 15-18 months rent free on a 10-year term – down from 18-24 months in January, according to Colliers International.
The second quarter has been characterised by a lack of large deals. Only one deal for space of more than 50,000 sq ft has taken place in the City and Docklands: News International’s 70,000 sq ft letting at Land Securities’ and Cadillac Fairview Corporation’s Thomas More Square, E1.
“The City market is tightening as we see the lack of development start hitting the pipeline of new space being delivered to the market,” says James Young, a partner at Cushman & Wakefield. “Occupiers are still cautious about making decisions, but the prelet is going to make a comeback, because options remain limited for a company that wants to upgrade its space.”
Aon, CMS Cameron McKenna, Schroders, Trowers and Hamlin, and Bank of America together account for more than 1m sq ft of potential demand, and most of these companies are likely to consider prelet options. British Land’s 621,000 sq ft Cheesegrater, EC3; Land Securities’ 639,000 Walkie Talkie, EC3; Core’s and Monteverde’s 170,000 sq ft 6 Bevis Marks, EC3; Stanhope’s & Schroders’ 167,000 sq ft 70 Mark Lane; Shieldpoint’s 250,000 sq ft 76-86 Fenchurch Street, EC3; and Arab Investments’ 1m sq ft Pinnacle, EC2 are all possible prelet contenders.
Media giant eyes EC4
Bloomberg’s 500,000 sq ft requirement is set to be satisfied soon; the media giant is eying space in Legal & General’s Walbrook Square, EC4. This can also be said of MF Global, which is close to taking more than 100,000 sq ft at Wafic Said’s 313,000 sq ft 5 Churchill Place in Canary wharf, E14.
The fall in active demand can be attributed in part to the satisfaction of pent-up demand from occupiers during the first quarter, such as Shell’s 187,000 sq ft letting at Canary Wharf Group’s 40 Bank Street in Docklands, E14; BlackRock Investment Management’s 270,000 sq ft letting at Drapers Gardens, EC2; and Macquarie Bank’s 212,000 sq ft letting at British Land’s Ropemaker Place, EC2.
These occupiers had been eyeing a move for a number of years before committing earlier this year, and this trend has been compounded by some corporates returning to the “wait and see” approach until after the election and subsequent Budget. However, structural demand from occupiers with lease breaks or expiries over the next three years could account for as much as 3m sq ft, says Drivers Jonas Deloitte.
Having hit the bottom in the third quarter of 2009, prime City rents began to rise the following quarter, rising to £50 per sq ft in the second quarter this year from £46.50 in the first quarter, says Knight Frank. Further rental increases are expected in the second half of the year, but at a slower rate than the past six months, with prime City rents forecast to increase by around 50% from end 2009 through to 2012-13.
“I expect the occupational market to continue improving over the medium term after a short-term pause for breath,” says Mark Bourne, a partner at King Sturge.
