Bank-occupied offices ‘better’ than equities

Investors are unlikely to see all their equity wiped out if they invest in bank-occupied offices in the City of London, making owning the office better than owning shares in the banks themselves, it was argued today.

In a commentary on the defensive value of real estate and the Euro crisis, CBRE’s chief EMEA economist, Peter Damesik, said that buying real estate provided investors with the reassurance that, even in the most extreme circumstances, it was unlikely they would experience a total loss. He cited as an example the collapse of Lehman Brothers in 2008 and the subsequent fate of the European offices occupied by the bank in London’s Canary Wharf.

“The experience of the Lehman collapse and the bank’s UK headquarters in Canary Wharf provides a clear example,” pointed out Damesik. “It is unlikely that either bondholders or shareholders will get a substantial return from the winding up process. Even senior bondholders are expected to see a return of less than 25 cents on the dollar (yet) contrast this with the position of the former owners of Lehman’s UK headquarters. The administrator continued to pay most of the rent while the European operations were transferred to Nomura, with Lehman’s sub-tenants in the building providing additional security of income.  Subsequently the building itself was sold to JP Morgan for £495 million (€618 million; $772 million). Extrapolating from this specific example to the general shows that over the last five years investors would have been much better off owning buildings occupied by banks in the City of London  rather than shares in the banks themselves.”

CBRE has produced a chart comparing the total returns from office properties in the City of London with returns from bank shares included in the FTSE100 Index since the end of 2006 to provide a stark illustration of the relative merits of the two asset classes.

Damesik argued that further defensive features of commercial real estate at present include the low level of new supply in most European markets.

He said the credit crunch in 2007, 2008 “cut off” the supply of development finance and new construction starts across all real estate sectors. In Western European cities, the annual level of new office completions is now running at historically low levels, he pointed out. Further, across the region, delivery of new space is averaging around 1 percent of stock per annum.  Continued tight constraints on development finance will keep supply in check for an extended period and the low level of new development over the next few years will help to protect rental values in the likely event that demand remains subdued.

Concluding his comments, Damesik said real estate markets will not be immune from  the adverse effects of a worsening euro crisis. However, prime real estate has significant defensive and positive attributes relative to other assets and should continue to attract capital to European property markets through very challenging times.

CBRE’s EMEA economist said the euro crisis was pushing investors towards greater caution, most often by avoiding specific eurozone markets and/or focusing on lower risk assets. 

“The attraction of larger, liquid markets perceived as ‘safe havens’ is working strongly to London’s benefit as is its position outside the euro.  London accounted for almost 22 percent by value of all commercial property investment transactions completed in European markets in Q1 2012.  The ‘safe haven’ effect in also clearly seen in London’s prime residential markets with a larger number of buyers from southern Europe looking to move their capital out of Euros.”
   
He also said investment activity in southern European markets – Italy, Spain and Portugal –  has fallen sharply since 2010. In the first quarter of 2012, as purchasing activity in European markets slowed generally, turnover in southern Europe decreased by 65 percent from a year earlier. Italy, Spain and Portugal accounted for only 2.6 percent of total sales in Q1 2012.  Conversely, the UK and the Nordics together with the strong German market captured 78 percent of European commercial real estate investment activity in the first quarter of 2012.

However, if exits from the euro do occur, Damesik argued that with significant depreciation of the new currencies, cross-border investors would see “marked shifts” in the relative pricing and attractiveness of real estate assets in different national markets within Europe. He said a deepening euro crisis would most severely affect southern markets, depress real estate transaction volumes, lead investors towards safer havens, lead to banks suffering bigger losses on property loans, hit secondary values further, and curb bank debt even more sharply.