Agents are adjusting forecasts, but remain confident that the underlying market remains strong.
What a difference four weeks can make. Speaking to West End investment agents in August, there was a note of caution in their reports – but with an underlying bullishness.
The message was one of an imminent price adjustment – fewer buyers but the core principals of the market remaining robust.
A month on and with headlines such as: “Credit squeeze grows to worst for 20 years” “High Street sales crash looms” and “Credit crisis could halt property deals”, the jitters have well and truly entered the market.
Those who spoke in August have already adjusted their forecasts for the year (see panel). The market is in for a bumpy ride, but will the West End, with its chronic shortage of supply, international occupiers and spiralling rentals, get travel sick?
The increasing cost of debt had already stripped the market of high leveraged buyers, and this has not changed. But the situation has become more acute with the collapse of the sub-prime market leaving many lenders exposed. In addition, the interbank lending rate (LIBOR) is increasing.
The full extent of the banks’ exposure will be known in the coming weeks as many financial institutions will be reporting but, in the meantime, banks have become more cautious about lending and are putting up the cost of debt.
“Bank funding is drying up or has dried up,” says John Mundy, West End investment director, DTZ. “Most buyers that use debt suddenly can’t find the money and can’t get the returns. Therefore, they will sit on the fence to see what happens to the market,”
Agents’ underlying optimism in the West End’s prospects is fuelled by the supply and demand equation.
The chronic shortage of supply has pushed up rents, with prime rising by an unsustainable 40% in a relatively short period of time. The supply chain remains restricted (see p139), and demand is still robust – for the time being.
Even if rents did cool a little, it would surely not affect the majority of the market (see p148), particularly those that bought stock off much lower rents and before capital values peaked?
But if profit margins are squeezed – and there are already signs of that in certain business sectors, the property sector included – it is never going to look good to shareholders if deals are signed on sparkling new West End buildings at bulging rents.
It is mostly “ifs” at the moment. The little evidence that does exist has come in quite high-profile form. Less than two weeks ago, Estates Gazette reported that IVG Asticus’s proposed £140m purchase of 7-8 St James’s Square, SW1, had collapsed. The effect of the credit market turmoil on high-end occupiers was rumoured to be the reason.
“It’s not Armageddon,” says DTZ’s Mundy. “In my book, that’s when we have massive oversupply and demand completely dries up.”
The West End’s global appeal is also providing some comfort to investment agents. Clive Bull, head of central London investment for Cushman & Wakefield, points out that overseas investors have a different criteria, adding: “They aren’t going to be worried about paying 4-4.25%, but will see it as a defensive play.”
With debt buyers just about priced out of the market, the spotlight is now falling on those with the ready cash, such as the overseas investors and property companies. The market view seems to be that the “wait and see” stance of August will continue through this month and into October.
Mundy says investors with asset allocations to make up may bide their time waiting for the yields to soften a little. “If pricing moves out by a quarter or maybe more, the question is where the trigger point could be for the buyers to jump back in.”
It is the million-dollar question, and one that cannot readily be answered. Richard Womack, head of West End investment at CB Richard Ellis, adds: “Some property companies will believe this is a pause and will take an opportunistic buy. Given the relatively robust state of the UK economy, and the view that the market will hold up reasonably well through to next year, why not buy now?”
But all this is assuming that the worst does not happen. Simon Glenn, investment partner at Strutt & Parker, believes that the end-of-year accounts will stimulate the market. “Banks all have targets to hit, and one will assume they will be back. I can’t see the likes of Goldman Sachs sitting on its hands for two years.”
There is a tendency in the agency world to talk the cup-half-full senario, but at this time there is an underlying nervousness born out of what is probably the most unpredictable time the market has seen in a long while.
Guaranteed, the West End is strapped in more firmly than the City, which has a bulging office-supply pipeline but, nonetheless, it is going to be a slightly uncomfortable ride for the next few months.
Then and now
Back in early August there were signs of cooling in the market, but agents spoke of the inevitability of a price adjustment after such a prolonged period of strong performance, rather than crashes.
The summer holidays were blamed for making the market difficult to analyse. The message was “call back in September, then we’ll see”.
The uncertainty remains but, in the space of four weeks, the predictions have already been adjusted.
- Simon Glenn, investment partner, Strutt & Parker
August “We’ve already transacted £3bn this year, the annual average is £2-3bn. I estimate £6bn will have been transacted by the end of the year.”
September “It will be more difficult to transact £6bn now. Some people will sit on lots until next year. We could still see £5bn transacted by end of the year.”
- Richard Womack, head of West End investment, CB Richard Ellis
August “It is only a matter of time before yields are adjusted. Many houses will move yields out by a quarter point by the end of the year.”
September “CBRE has already moved its prime yield from 3.5% to 3.75% and is forecasting a weaker trend.”
- John Mundy, West End investment director, DTZ
August “Yields might move out a quarter or half a point by the end of the year.”
September There is clearly a knock-on effect in the market. There is no hard concrete evidence of yield shift yet, but we have moved prime yields out to 4% from 3.75% and may move a further quarter.”
