In the wake of the credit crunch, the extent of the damage to the West End property market is becoming apparent.
In the skyscrapers on Wall Street, the bankers have their heads down. It is reporting season, and with shoulders hunched over spreadsheets, they work late into the night frantically totting up figures trying to assess the damage that a summer of jitters has inflicted on their bottom line.
Across the Atlantic, the pinstripe suits in London nervously await the outcome. Only those holidaying in the remotest reaches of the Caribbean can have escaped phrases such as the sub prime housing market, NINJA (No Income, No Job, No Assets) loans and the credit crunch.
By August, a few bad days on the Stock Exchange had started to look more serious. Investment banks such as Bear Sterns, BNP Paribas and Goldman Sachs were using their own money to bail out hedge funds and prohibiting investors from cashing funds. The European Central Bank poured in more than $140bn to soothe turbulent waters and the Bank of England soon followed suit.
Hedge funds, which only last year were being held up as the bright, exciting future of the West End’s property market, are beginning to look like the problem.
This month, the market will find out just how big the losses are. Up until now, those holding bad debt have been unable to trade their assets, so the extent of the damage is hazy. However, credit agency Standard and Poor’s estimates that investment banks’ profits could slide 50% in the second half of the year.
With Labour Day and the Federal Reserve’s rate decision now out of the way, the horrible truth is beginning to leak out, and with it the impact on the West End office market.
Rewind just a couple of years, and landlords welcomed financial occupiers to the West End. Nowadays, agents claim Mayfair is more financial than parts of EC2. For example, a decade ago, financial occupiers represented 18% of take-up in Mayfair and St James. Today, they are closer to half.
Demand from private equity, wealth management and hedge funds have driven that increase, with that from the latter easily outstripping the other two.
According to Eurohedge, in 2006, 423 hedge funds started up in the UK and, in the first six months of this year, another 189 had made the UK their home.
With stock at its lowest levels since mid-2000, West End rents quickly shot up. Many gasped in Q1 when £102 per sq ft was achieved, but by Q2, that had risen 17% to £120 per sq ft. Now US fund manager Permal Capital has agreed to pay £140 per sq ft for a refurbished office at 12 St James Square, SW1. Whispers suggest that 65 Grosvenor Street has received promises from tenants to pay £150 per sq ft.
The problem for landlords is that, with debt being split and shuffled throughout the financial world, finding out who is truly exposed has been all but impossible. Hence, differentiating a good and bad covenant has become much trickier.
As a result, landlords have become more cautious, says George Roberts, director in office agency at Jones Lang LaSalle. “Over the past few weeks, the world is suddenly a different place. It is not as bad as we thought and nobody is asking for two years’ deposit, but the microscope is now more tuned, and landlords are looking closely at the backers and the equity actually in the fund,” he says.
Roberts admits that certain sections of the market are fairly exposed, but the market is unlikely to see mass insolvencies as one hedge fund’s hell is another’s heaven. As a result he warns: “Six months ago no landlord would have asked if their hedge fund occupier specialised in sub prime or emerging markets. They are having to understand the underlying businesses much more.”
The knock-on effect is on high rents. “We will see the froth come off the marketplace,” says Roberts. “One of my hedge funds contacts said there was a storm coming, but storms do pass over. He said the medicine issued by the central banks is helping by giving extra liquidity, and that is slowly working its way through the system. There’s less competition for space at that top end but there are still viewings taking place, and we are telling clients that the market can support space at that £100 level, however, deals will slow down.”
In the financial sector, the finger-pointing has already begun. The market is now pondering the wisdom of building a business based on selling mortgages to people with no jobs and no savings. Greed has often been cited as a common factor – were landlords too guilty of this?
Space rivalry
In a sunny market, nobody could blame landlords for making hay. Competition for stock among hedge funds has been fierce, explains Simon Tann, senior director at CB Richard Ellis. “A lot of these guys had already lost out on a building, and were having to explain to the chief executive officer who had flown over from the US to look at an office why it had gone and there was nothing else to look at,” he says.
Some hedge funds could collapse, but there are no signs of an industry- wide meltdown. As a result, Tann believes top-end rents are sustainable. “We are nowhere near the limits of what these occupiers can afford. If they wanted to they could afford to push it at least another 25%.”
Others in the property industry say the impact of the market jitters will be minimal, pointing out that hedge funds are a handful of small companies in relatively small amounts of space.
Andy Heath, associate director at Strutt & Parker, is one of those. “We’ve not had any fallout, if it was going to be dramatic, and everything is so instantaneous, then why haven’t we seen it yet?” he asks. “We are in a strong letting market, and we just aren’t seeing the hedge funds being knocked down. There is money coming into the market.”
Pointing to demand at an all-time high of 5.7m sq ft and supply at just under 4%, he adds: “Landlords are protected. They are getting big deposits, and they are not accepting poor covenants. Many occupiers have US-backed parent companies that have learnt their lessons from the dot.com boom.”
But while landlords may be protected by large deposits, long leases and rental guarantees, empty buildings seriously drag on any market’s morale.
Not everyone is sure that lessons from previous slumps have sunk in. John Forrester, director at DTZ, says : “Some think that if you do a letting today and the company goes under in three years’ time you’re not worried because you think you can relet it. But that’s in a good market. You’ve got to know what the property cycle will be doing then. If it’s bad, then you’re probably not going to relet it.”
However, he tempers this by saying: “London landlords are pragmatic. You don’t just walk in, pay a high rent and put your desk down.”
Forrester says that in the dot.com boom “companies were looking for lofts in Covent Garden, so it really didn’t affect the whole London market.”
He adds: “Hedge funds might be 2% of take-up, but their impact is exponential. When you talk to the property companies and the institutions, they talk about the rents achieved in the West End being what’s achieved off two or three floors. When developers start making proposals stack up against these anomalies, and this false wisdom becomes embedded in the mainstream, then things start to look risky.”
There are parallels to be drawn with the late 1990s, he believes. “There was a pause in the market created by volatility in Russia and the South American debt market, but then it picked up from where it left off,” he recalls.
Forrester says it is too early to say if this will happen today, especially as many businesses operate on a 20% failure rate.
“Who does that?” he asks. “You’ve got to advise the landlord about what he is going to take for credit, and he’ll probably want three years’ on deposit.”
Of course, overheating in the West End has been a worry for some time. In June, Westminster council commissioned Drivers Jonas to investigate whether the high costs of renting commercial property in central London had lowered the competitiveness of the city as a commercial centre.
The West End market has always traded on the fact that its varied and diverse occupier base allows it to weather storms. By inviting in financial occupiers, landlords may have thrown out their biggest asset.
This quarter it will find out just how much it was worth.
