London is currently dominating the global property market, but the question we must ask ourselves is: for how long?
The capital’s commercial real estate market is due for a correction. Last year, investors ploughed more than £20bn into central London – just a shade lower than its 2007 peak.
Although fund managers feel the ghosts of 2008 all around them, poor returns elsewhere keep the money flowing in. We should investigate the alternatives now or risk disaster.
London is riding the wave of high occupier demand, low interest rates and short supply. Positioned outside the euro zone, the city looks even more attractive compared with its European peers. However, as
prices rise, the risk-reward is looking increasingly skewed.
In the medium term, London’s dominance is likely to come under threat as more viable alternatives emerge from within the euro zone. If the euro stabilises, or Italy and Spain’s economies recover, cities such as
Barcelona, Madrid and Milan will offer far more attractive returns than London’s
over-cooked market.
While we will not see the deserted office blocks that were a feature of 1990s London, the turnover of buildings is likely to slow as demand eases off. In the best-case scenario, we will see a gentle price correction as other markets become more fashionable.
In the longer term, we are likely to see the Far East overtake London as an investment destination as economic power shifts away from Europe.
In general, investors tend to look at local markets first, then regional, and then global. If investment pools are increasingly concentrated in the Far East, then it is unlikely that the money will flow to the UK, particularly given the vast investment there.
The risk is that London will become yesterday’s news.
London will undoubtedly remain a major European financial centre, but that would be a significant fall for what is currently one of – if not the – world’s financial capital. The markets in the Far East have significant growth potential, leaving London behind in the investor mindset.
As capital flows away to faster-growing Eastern markets, demand will fall further, potentially sparking a vicious circle in which prices drop sharply.
London is particularly vulnerable to changes in the geo-political environment. More than 70% of its commercial real estate stock is held by overseas investors. While some of these investments will be held by sovereign wealth funds seeking returns over the long term, private equity investors will chase higher returns available elsewhere.
There is little we can do to control such a shift of economic power on this scale. However, the government can mitigate some of its effects by ensuring that London holds on to its European top spot.
London is an old city, and the more buildings and people it hosts, the more infrastructure it will need. The government’s willingness to actively promote infrastructure investment, and to adopt policies that reinforce London’s status, will be a key factor in its longevity.
For example, a clear decision on airport runway capacity in the South East is essential. If those controlling global capital cannot access London easily, they are less likely to invest here. London must remain a gateway for international investors into Europe.
It is impossible to predict what will trigger a price correction. It might be the emergence of new markets, uncertainty surrounding the UK’s status within the EU, or something else entirely.
What is certain is that the current price increases are unsustainable and yields are too low given the current level of risk. Ultimately, values will fall.
Investors should seriously consider the potential challenges to longer-term London property values when making their investment decisions.
Richard White, UK head of real estate, KPMG
