Election fever gripped the UK this year as the participants at PERE’s UK round table discussion met in the West End of London on 30 April. The poll had been hailed as one of the least predictable in history and was widely expected to result in a coalition or minority administration with no party able to secure a parliamentary majority.
A little over a week later in the aftermath of the general election the one prediction that came to pass was that the result was indeed unpredictable. To widespread surprise the Conservative party of the center-right secured a slim overall majority of 12 seats, enough to ensure that they can now govern alone without the need for support from the Liberal Democrats, their coalition partners since 2010.
Whether the election outcome is good news for property investment in the UK remains debatable. Some of the pre-election worries expressed by the four round table participants – Jonathan Hull, managing director for EMEA capital markets at real estate advisors CBRE; Martin Towns, head of capital solutions at fund manager M&G Real Estate; Simon Cooke, director at asset management specialist APAM and Alessandro Bronda, head of global real estate investment strategy at Zurich Insurance – will have been laid to rest, but other concerns will perhaps have intensified.
The European question
In their pre-election discussion of the implications of the election result the roundtablers focus on two principal issues: taxation and European Union membership. While the threat from a Labour government is perceived to be increased taxes, the danger of a Conservative administration is that it will open up the question of Britain’s status as a member of the EU.
The likelihood of an increased tax burden on business has receded with Labour’s electoral failure. However, the new Conservative government has pledged an in/out referendum on EU membership by 2017 and the post-election signals from Downing Street suggest it could be held as early as 2016. That seems a much more distant prospect to the participants as they conduct their pre-election analysis, but they highlight it as a potential threat to the stability of the market nonetheless.
“Capital markets’ fear about this election is that we will change the fundamental basis on which investors can come and go into this country,” says Cooke. As an illustration of what is at stake he raises the spectre of a flight of capital and major financial institutions: “It is public knowledge that HSBC are doing their reassessment of where they are going to be based.”
He explains why leaving the EU would potentially be bad for business: “It would have a major impact on growth because you would end up with a more challenging importing and exporting environment and you have a very important supply of labour flowing both ways. There are companies occupying buildings in the UK that would find it very difficult to operate here if there wasn’t a competitive labour force. The whole expansion of the logistics world has been based upon a low cost of labour and a very high investment in buildings. That might change if our free trade is curtailed.”
Towns says that the European question has not yet come to the forefront of investors’ minds. “The percentage chance of there being a Conservative government in power which has the ability to offer a referendum followed by the UK population voting to leave the EU seems relatively low at present given recent opinion polls. It is not something at the moment that international investors tend to raise with us.” However, he adds that “if you have a conservative government in power with the ability to offer the referendum then the question perhaps becomes more relevant.”
Meanwhile Bronda expresses faith that a majority of UK voters will cast their ballots on the pro-European side: “The EU is the UK’s most important trading partner so even if it does come to a referendum I am not sure the Brits will want to pull out,” he says.
Whatever the eventual result the uncertainty in the run-up to a referendum could have a negative impact on occupier sentiment, suggests Cooke. He uses the recent referendum on Scotland’s membership of the UK as an example of how difficult it is to get tenants to commit in an atmosphere of uncertainty.
“Our refurbished CityPark office building in the outskirts of Glasgow has the cheapest and largest floor plates available in a city that has incredibly high quality cheap labour and is a preferred destination for call centre activity,” claims Cooke. “Dell is one of the existing tenants and they would not renew their lease or expand into the building until the Scottish referendum was over. We have let 120,000 square feet after the referendum. So if we think that political risk in relation to Europe doesn’t have some impact we are fooling ourselves.”
Another political hot potato is UK’s housing shortage and consequent rocketing residential property prices, but the panellists express scepticism about politicians’ ability to encourage the large-scale house building needed to address the issue.
“Whatever policy is implemented it is probably tinkering around the edges in the context of the supply and demand issue we have at the moment, particularly when you are talking about quality rented accommodation because what we do have in many areas is not fit for purpose,” says Towns.
He foresees that the expansion of institutional-backed private rented sector (PRS) housing can address “quite a big part” of the shortage. M&G has invested over £130 million through the PRS fund that it established a year ago.
Large-scale institutional quality PRS housing is still a fledgling sector in the UK, however. Hull says: “The UK was a unit by unit market. In the US it is a purpose-built rented multi-family PRS sector. You are now getting those schemes here so we are going through a very big change.”
In the meantime high prices are preventing many British people from gaining a foothold in the owner-occupier market. When asked whether capital current values deter investors in the sector, Towns points out that “much of the country’s owner-occupied housing stock either doesn’t have a mortgage or has a relatively small one; so housing is not so unaffordable for those already on the ladder, thereby helping support capital values in many areas.”
Overseas buyers are very prominent in the UK and especially in the London market. Over recent months high profile assets like The Gherkin and HSBC Tower have been sold to foreign purchasers meanwhile core central London assets attract long lists of overseas bidders willing to pay keen prices. An office block at 95 Wigmore Street recently attracted 14 overseas bidders and sold at an initial yield of 3.4 percent. “The amazing thing is for all of the prime deals there are so many bidders,” says Cooke.
Hull adds: “And all of them are going in with no debt. It is an equity-driven market.” He argues that Europe offers stability for overseas buyers, in particular Asian investors, seeking a safe haven for their money, and that London is the most stable market of all European cities. Meanwhile an economy that is performing more strongly than many of its European competitors and a favourable tax environment further underpin the UK’s attractiveness to investors.
“The depth of the capital is the trend,” says Hull. “The market this year is defined by scale. In previous years we didn’t see portfolios trading at €500 million to €1 billion. This year investors are pooling assets and looking to exit because capital has such a demand for real estate. A lot of the Asian investors are looking either at very large assets or portfolios.”
While Asian investors frequently dominate the bidding for core assets in the UK, American capital is focused on the opportunistic sphere. “The dominant American money is opportunistic and it is very comfortable in distress, leverage and recovery,” says Cooke.
Many equity-rich foreign buyers are eschewing commingled fund vehicles, preferring instead to invest directly in UK property, frequently in partnership with a local manager.
Zurich, which is seeking to invest in UK core and core plus assets, fits that description exactly: “We like to hold real estate directly. We don’t invest in funds, and in markets where we don’t have people on the ground we appoint a manager to build a portfolio for us. Last year we awarded a mandate to CBRE Global Investors to build a £200 million portfolio,” says Bronda.
Two of Bronda’s fellow-panellists are actively seeking to provide local expertise and management services for incoming capital. Towns was appointed in March to lead a new team at M&G which provides solutions to large overseas institutional investors that prefer not to invest through funds.
Meanwhile APAM, which Cooke co-founded in 2010, initially focused on providing a service for banks seeking to manage distressed assets, but is now increasingly acting as an operating partner to private equity capital: “We have done £500 million of business in the last 18 months with Patron Capital and Värde Europe buying difficult regional UK assets and managing them through on a co-investment basis,” says Cooke.
While the buyers are often foreign the managers are frequently more familiar, adds Hull: “When you look at the bidding lists you see the same investment managers in there with capital from all over the world, but it is the managers that are leading the charge.”
The weight of money coming into the market has pushed yields to record lows, but still prices are increasing, in particular for prime London real estate. “One of the attractive things about UK real estate is the spread between the risk free bond rate and where yields are at the moment so even if yields are quite low in a cyclical sense that spread is still quite high,” says Towns.
Currently the gap between bond returns and real estate stands at around 300 basis points. Bronda believes that as long as it stays at 200 to 250 points or more real estate will remain an attractive investment for its risk profile.
Towns believes that even if the gap closes further economic growth will maintain yields: “The thing that supports real estate is that even if you get a tick up in the risk free rate and interest rates it is probably because you are in a stronger economic environment and therefore you have the prospect of rental growth to continue to support prices.”
Can yields continue to come in? “The world is in an asset bubble fuelled by cheap cash,” warns Cooke. “There is €1.5 trillion of quantitative easing floating about Europe. That is distorting people’s investment judgement in relation to the risk-free rate, right pricing and when interest rates are going to go up. The problem that stops me sleeping at night is how inflated is that asset bubble?”
The worst risk facing the market is that a too-sharp rise in interest rates will trigger a global economic slowdown, says Bronda. “The yield component will come to an end soon and the returns from real estate should be driven by rental growth,” he argues. “The outlook is good because vacancies have come down everywhere, especially here in London, and the supply pipeline is very limited.”
Hull argues that the diversity of capital sources underpins the robustness of the market: “The profile of the investor list for some sales in the West End recently have been made up of mostly non-UK money – around 80 percent is coming from global institutions, family offices, the Middle East, Asia and the US. They are not all the same kind of investor. You have different profiles of equity and capital chasing the same kind of asset.”
The UK real estate investment market is currently enjoying a golden period, but how much longer can the current cycle run for? Cooke says: “You will see a yield correction and the hot capital will disappear in 2017.” Hull and towns plump for 2018; Bronda for 2019.
The UK regions
London is enduringly popular with property investors, but what of the UK regions? Will provincial towns and cities see an influx of capital seeking higher rates of return? Zurich, for one, is following that path: “We haven’t really been investing in central London because it is too expensive. We have looked on the fringes of London and also in the regions,” says Bronda. “There is much more value to be had in Guildford or Northampton. There are good assets to be found and less competition as well. We have invested about £60 million in the last 12 months in five or six assets.”
The other investor round table participants are also active in the regions. M&G has been one of the most active investors outside of central London in recent years, particularly in city centre offices. Towns says: “We have been capitalising on both the higher income yields available outside of the prime, central London markets, but also the lack of modern, high quality office space on offer in the South East as well as key regional city centres.” He adds that, “given this shortage, we are now seeing rental growth as well as strong occupier demand for the new buildings we are delivering in these markets.”
He adds that because of a lack of development over recent years there is now a shortage of good quality office space in the regional cities, which is prompting rental growth and a modest return to speculative development.
APAM’s 300,000 square foot CityPark office scheme in Glasgow is an example of increased liquidity. “When we took it on you couldn’t have sold it to anybody even at a hugely discounted price. Three years of loving care and capital investment later we are inundated with enquiries form all sorts of people to buy that building – even Asian capital. The natural and obvious progression for capital is out from London to Birmingham, Manchester, Leeds, Glasgow and Edinburgh,” he says.
Debt and finance
Who is lending to finance real estate transactions? “Who is not lending?” responds Towns. “Everybody is lending,” confirms Cooke. “Every major UK-based bank has a debt team to lend money into the marketplace – even the ones who still have balance sheets pregnant with old defaulting debt because they have separated those loans out. The diversity now of the debt market is huge. When we went through the last bubble there were only really banks who would lend you the money.”
He identifies the American investment banks as willing to lend at the highest loan-to-value ratios and at lowest margins as they try to engineer their way into big loan books. The big high street banks also continue to lend and are now supplemented by institutional debt funds.
“Across the debt capital stack you have a whole range of different players at different profiles, but there aren’t that many people who can provide a comprehensive solution,” says Towns. “So although there is an increasingly competitive market in terms of margin what our business seeks to do is provide a solution across the stack – senior, stretched and junior in some cases. People are competing on offer as well as on price.”
Hull suggests that while debt has become freely available in the UK once more it is equity that is driving the market today: “When you compare 2007/2008 to today the debt proportion is much lower. The banks are not fuelling demand in the same way and debt is coming from a much broader spread of players. London is a very liquid market, but if you go into Spain and Italy debt is still a challenge. It is not the same as it was before. In 2007-2008 you could borrow money almost anywhere in Europe for almost any deal and it would be 90 percent to 95 percent loan-to-value,” he recalls.
Cooke highlights a regulation that could soon have a significant impact on the UK market. Under the Energy Act 2011 the letting and sale of inefficient buildings with F and G-rated energy performance certificates (EPCs) will be outlawed from 1 April 2018. “There will another government fob-off, but currently a large proportion of UK real estate is F or G rated,” he warns. “With a few exceptions the investment markets have ignored this for some time. If investors don’t improve their buildings then they will end up with a bigger cost down the line – more capital expenditure, more obsolescence and therefore a more burdensome investment.”
Cooke and Hull feel that the green agenda has been put to one side to some extent while the focus has been on economic growth. The participants agree that it must be taken seriously, however.
“We try to invest in very energy efficient buildings and we have some internal guidelines to reduce the amount of emissions that we have in our portfolio,” says Bronda.
Towns adds: “It is something we want to do, but we have increasingly seen that trend that our investor base take it very seriously as well. One of their criteria when they consider whether to appoint us as managers is whether we are actually doing something about it.”
At the close of the discussion the participants are asked what will be the hot topics at the 2016 round table. Towns believes there could be more capital growth to come: “We might well be discussing the fact that we saw further yield compression over 2015, despite people having thought we had already reached a cyclical low point,” he says.
Bronda disagrees: “We will be talking about the degree of rental growth because capital compression will be gone and returns will be driven by rents.”
Interest rates have remained at a record low of 0.5 percent for a six-year period, but Hull thinks that might change next year. “We could be discussing when interest rates are going to rise,” he suggests.
Cooke returns to the political theme: “Greater political uncertainty will cause significant concern to investors. There will either be the European problem or there will be a taxation problem or both. The impact of the election will manifest itself over 12 months,” he predicts.
If an EU referendum does indeed take place in 2016 then his forecast will appear farsighted. Next year we may discover whether the confidence of a booming UK investment market can survive insecurity over the country’s place in Europe.
Managing director EMEA capital markets
Hull has worked at CBRE for 18 years. He leads the capital markets team that comprises 500 professionals across 44 countries providing advice to property investors on acquisition, equity and debt funding, transaction structuring and disposals. The team transacted over €40 billion on behalf of clients in 2014, and completed 114 deals each in excess of €100 million last year. CBRE Capital Markets transacted over $100 billion around the world in 2014.
Head of capital solutions
M&G Real Estate
Towns was appointed to his current role in March this year to provide separate account strategies, joint venture vehicles and club transactions for investors seeking direct real estate exposure. He previously managed a £9bn separate account for M&G Real Estate, which manages £22 billion ($34.5 billion; €30.4 billion) of assets predominantly in the UK, but also in continental Europe and Asia on behalf of parent company Prudential and other clients. Towns’ 13 years of real estate fund management experience also includes time at Close Brothers as director of commercial property.
Cooke is a founding shareholder of independent UK real estate asset and investment manager APAM, which manages just over (£1 billion $1.57 billion; €1.38 billion billion) of UK property. His responsibilities at the firm include asset management strategies and business development. Prior to founding APAM in 2010 Cooke was managing director of Close Brothers property investment division. A veteran of the UK commercial property scene with 33 years’ experience he began his career at Richard Ellis (now CBRE) in 1982.
Head of global real estate investment strategy
Bronda is in charge of developing global long-term and short-term investment strategy at Zurich, which manages $12 billion of real estate assets globally. He joined Zurich in March 2014 after eight years at Aberdeen Asset Management in Brussels, where he was head of global property investor solutions and before that led the global investment strategy and research team. Prior to Aberdeen, Bronda worked for the Catella Property Group in Brussels as the head of European research. Previous employers include Security Capital, Eurostat, the statistical office of the European Union and the Ifo-Institute for Economic Research in Munich.
DEAL WATCH 1: A London Spectacle
Gherkin sell-off attracts global interest with $40 billion of eligible capital interested in the office tower
Last autumn the sell-off of one of London’s best-known modern landmarks caught the imagination of the global property industry. Around 200 bidders from around the world registered interest in The Norman Foster-designed 30 St Mary Axe in the City of London, affectionately known as The Gherkin because of its distinctive shape.
Around 40 percent of the interested parties were of Asian origin, but in November Safra Group, owned by Brazilian billionaire Joseph Safra, was confirmed as the winner with a £726 million ($1.1 billion; €1 billion) bid including £365 million of finance from Dutch bank, ING.
“For me last year the most spectacular deal was the Gherkin,” says Bronda. “What struck me was the level of interest for the lot size and price. That was transacted at over $1 billion and I believe there were 40 eligible bidders for that so that is $40 billion altogether.”
Built in 2003 the lower floors of the skyscraper are let to insurance company Swiss Re, which owned the building before selling it to private equity firm Evans Randall and German property investor IVG in 2006 for £630 million. The office block went into receivership in April 2014 after the partnership defaulted on a number of loans largely because IVG had borrowed in Swiss francs.
The Gherkin may have been the most iconic London skyscraper sold last winter, but it was not the most valuable. In December sovereign wealth fund Qatar Investment Authority (QIA) completed the UK’s biggest office deal in history when it purchased HSBC’s headquarters at Canary Wharf for £1.1 billion.
The 45-storey tower’s previous owner the National Pension Service (NPS) of South Korea paid £772.5 million in cash for the asset in 2009. The counter-cyclical transaction raised eyebrows at the time, with many commentators believing that NPS had overpaid, but the investor was proved right as it netted a handsome profit.
DEAL WATCH 2: New heights
Wigmore Street sale demonstrates keen London prices
The weight of capital seeking a home in London has been driving up real estate prices for some time, but the 3.4 percent yield on the latest prime West End office deal remains eye-catching.
At the end of April the Great Wigmore Partnership (GWP), a 50,50 joint venture between Great Portland Estates and Aberdeen Asset Management sold 95 Wigmore Street to UBS Global Asset Management for a price of £222.4 million ($349 million; €308 million). When it was completed in July 2013 the development had a yield of 4.75 percent and value of just over £160 million. CBRE and Colliers International acted for the vendor. “That deal takes pricing to a new core prime level in the West End,” claims Hull.
The building comprises 83 percent offices by area with the remainder being retail space. It is let to tenants including actuaries Lane Clark & Peacock, private equity firm Bridgepoint Advisers and asset managers Pyrford International at rents ranging from £77.50 to £92.50 per square foot. The total rental income is £8.1 million a year and the current weighted unexpired lease term is around 10.5 years.
Commenting at the time of the deal Great Portland Estates chief executive Toby Courtauld said: “The sale continues our strategy of recycling capital out of assets where we have created significant value and back into our portfolio of central London development and refurbishment projects, timed to coincide with a shortage of new Grade A space to let.”