The princely sum of £200m sent ripples through London’s investment market at the end of last year. It wasn’t because the Arabs were once more pouring in the oil money. It was more that, instead of leafy Mayfair, they were turning their attention to the austere streets of the City.
As others were tucking into their Christmas dinners, the Abu Dhabi royal family – as part of a consortium of Middle Eastern investors – was negotiating to offer more than £200m for 35 Basinghall Street, EC2.
Although the building has since beenforward sold to Standard Chartered Bank for £118m, the royal family’s interest raised an intriguing question for some in the capital’s investment market. If the Arabs were moving away from their traditional hunting ground, would others follow?
Is West still best?
The West End had a bumper year in 2005. According to Knight Frank, it notched up a record £4.2bn worth of deals – a 55% hike on last year. But that is part of the problem. Drill down a little further, and a new trend emerges. Although more than 100 deals were completed, just 15 of them accounted for more than half the total invested. So, as the competition for buildings hots up, and investors look to invest ever larger sums of cash, will they sacrifice the better rental prospects in the West End and head for the larger floorplates and lot sizes of the City?
In the race to the top of the investment market, the West End is certainly ahead of the City. It achieved more than its fair share of record-busting deals last year. The Abu Dhabi royal family, far from abandoning its traditional territory, scooped a handful of West End properties of note, particularly Cavendish Square, W1, for which it paid £425m, reflecting a yield of 4%. It was the largest-ever investment deal in the West End. This followed a string of purchases, including 1 Curzon Street, W1, for £280m, and 1 Bruton Street, W1, for £115m – a price that equates to the West End’s lowest yield this cycle of 3.75%.
But while that yield might have had statisticians celebrating, it signalled a turning point for investors. “With prime yields on some of the properties in the West End, it is getting to a point where you can get more on your money by keeping it in the bank,” says Martin Lay, City investment director at DTZ. “We’ve seen Middle Eastern investment that historically focuses on the West End market – look at Basinghall Street, EC2, and Plantation Place, EC3. They need to get money into the market, and one way to achieve that is by coming into the City.”
The Middle Eastern spending spree is part of the problem. A policy of aggressively outbidding the competition combined with a strategy of holding investments for not years but decades, has caused a few headaches. Lay explains: “If there was stock in the West End, then I’m sure they’d be a queue of people, but how many more Cavendish Squares can there be?”
That is one of the reasons why Duncan Watt, head of European transactions at Invesco Real Estate, has looked at London’s Docklands. In October, Invesco, acting on behalf of US fund Teachers, purchased both 1 and 7 Westferry Circus in Canary Wharf for £206m, a 6% yield. “In the West End, you can count on two hands the buildings of more than £100m,” says Watt, “If you go to the City, you’ll need a few extra arms. The West End is undoubtedly a sexy charismatic market, but for larger lot sizes, you’ve got to look at the City or Docklands.”
Positive about central London
In general, Watt says Invesco remains positive about central London. “We are definitely recommending it as a buy for our clients,” he says. “We can cope with the very aggressive yields and the internal rate of return because we do see some rental growth coming through.”
In terms of rental growth, the West End has undoubtedly stolen the show. Headline rents rose £2.50 per sq ft in the last six months of 2005, to reach £75 per sq ft. Jones Lang LaSalle predicts nearly 11% rental growth this year, leading to double-digit returns. And more returns means more investors. Can the City show similar potential?
Stephen Clifton, head of city investment with Knight Frank, believes the finance sector will come to the City market’s rescue. “Growth in the banking sector is by far the largest driver,” he says. “They are the ones who can afford the highest rents in every cycle.” Bonuses are up, recruitment is back, and grey space has been taken off the market, he adds.
But the key source of optimism in the City market is CLOUT’s sale of its £520m stake in Citypoint on Ropemaker Place, EC2, in January, to Tishman Speyer. “It is a trophy building, one of the City’s largest towers, and a real multilet asset. It is truly a barometer,” says Clifton.
“It was an enormous start to the year, and gives us real confidence. If it had stayed on the market, it would have said something more serious, and shown that investors can’t deal with that size of asset. We do need to see rental growth to justify City prices, but there is more product here, and gradually demand is coming back.”
Halliwells partner Simon Hardwick. He admits that some of the increase in returns has been driven by hardening yields, but emphasises that this has been justified by rental growth. “It is already happening in the West End, but we have not yet seen it in the City, and it will be the latter half of 2006 before we see reduced incentives,” he says, adding: “There is a perception that the weak occupier market has bottomed out, and rental growth will encourage more people to be bullish and aggressive on yields.”
But what rental growth does not materialise? “If it doesn’t, then some of the decisions taken will look overly optimistic, and some of the yields will look hot,” says Clifton. But he adds, with a note of optimism: “2006 will be a year of consolidation and taking stock while rental growth gathers pace.”
|
Over the course of 2005, yields have shifted by more than 100 basis points. Will this continue? EG asked 10 professionals if yields could continue to harden at the present rate, or would the market benefit from a crash? Cold turkey: yields on hold Stephen Clifton, head of city investment, Knight Frank: “The City may improve 25 basis points in the first half. Rent reviews are coming at the right time of the cycle, but it won’t be the same as last year.” Simon Hardwick, partner, Halliwells: “I can’t see the driver for significant yield decompression. The market will end the year much the same as it is now.” Julian Sandbach, director of West End investment, DTZ: “It won’t be that different from today. Yields in the West End will not move back out to 6%.” Rob Johnston, head of Invesco’s UK real estate transaction team: “We live in a low-interest-rate environment, and unless there is a major jolt, I don’t believe we will see further yield fall.” Duncan Watt, head of European transactions, Invesco Real Estate: “The market is becoming more stable, and that might knock a few more points off, and that in itself might calm down emotions.” Julian Stocks, director of West End investment: “We are going to see a slowing down rather than a cooling, and bar the odd trophy yield, it has gone down as far as it is going to.” Hot potato: yields will tighten further Martin Lay, investment director, DTZ: “We are in territory not seen before. It will be slower this year, probably not another 100 basis points shift, but we could see 50bp.” Paul Henwood, City investment director, Atisreal: “It hasn’t peaked. Rental growth is still to come through. Who really benefits from a crash? They cause huge economic repercussions, as we have experienced before, and are usually coupled with a long recovery process.” William Naunton, partner Eversheds: “A crash? No. With retail and out-of-town stock looking expensive, the asset allocators are all calling for greater London weighting, and thiswill keep yields low and prices high for thenext year.” Charlie Butters, director West End investment, Atisreal: “The market is undoubtedly hot, but overheated? There is still the promise of further rental growth. If that disappoints, the market will adjust. Perhaps with a resurgent stock market, the heat would go out of London property without the need for a crash. It is probably wishful thinking, but in the meantime, there’s an awful lot of homeless money in the market.” |
