UK Property Market London & South East March 2011

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1 UK Property Market London & South East March 2011 Economic Background In January we reported that property yields had hardened substantially over the calendar year 2009 and that the UK stock market had also made significant advances since the lowest point in March At that time there were many uncertainties for the coming year including the UK General Election, which was held on 6 May This uncertainty caused some turmoil in the financial markets in the immediate aftermath of the election, particularly as it coincided with the Euro crisis triggered by the Greek deficit funding problems. The FTSE 100 fell sharply to 5132 at the close of business on the day after the election (down from a peak of 5825 on 15 April) and Sterling dropped to $1.45 at one point before ending the week at $1.48. The incoming government has many difficult decisions to make in cutting the public sector deficit and restoring confidence to ensure that the UK can continue to borrow at competitive rates. The financial markets appear to have steadied in the short term but this could change as more detail of policy compromises emerge and the first Budget of the new Government, scheduled to be presented within 50 days, will also test the markets. Unemployment levels have risen to over 2.5 million and will increase further as the previous administration s continued hiring in the public sector is reversed. UK house prices have sustained their recovery with annual growth of 9% over the last year but on very thin turnover. Commercial property investment yields have continued to harden during the first quarter of 2010, although at a slightly slower pace than seen in the last quarter of Official figures showed that the UK economy recovered in the final three months of 2009 with growth of just 0.4pc (revised upwards from 0.3%) but this recovery has not been particularly robust with growth of only 0.2% during the first quarter of 2010.

2 The Bank of England has held Base Rate at 0.5% for over a year since it was first dropped to this level in March Its policy of Quantitative Easing has ended for now but could be resumed if the economy falls back into recession. 3 month LIBOR hovers around 0.65% and SWAP rates have remained relatively stable, or even eased slightly for periods over the last quarter, despite the knowledge that when the Bank of England does decide to change rates there is only one way for them to go. 3 year SWAPs now stand at around 2.15% and 5 year SWAP rates are at 2.90%, however banks lending margins remain at close to 200 bps even for the strongest tenants and maximum loan to values remain around 65%. UK Property Market Trends Prime property yields continued to fall in the opening months of 2010 but the pace of the decline eased after the dramatic falls of late Cushman & Wakefield report that in final quarter of last year UK yields dropped by 66bps, ending the year at an average of 6.69%, compared with 7.56% in December 2008 and a peak of 7.68% in March This was the third straight quarter of prime yield compression. As a result of this yield compression, UK property capital values have continued to harden across all sectors of the market with the IPD Monthly Index for March 2010 showing an increase in UK capital values of 1.6%. This yield compression eased slightly in April to 1.0% reflecting nervousness ahead of the election. Over the 6 months to the end of March total UK property returns of 15.7% outperformed UK equities which showed overall returns of 13.5%. However over 12 months, property lagged with returns of only 16.3% compared to 54.1% for equities as the recovery in property capital values only really took hold during the last quarter of Central London Office Market Central London office leasing transaction levels were above average for the second quarter in succession. At 4.4m sq ft, take-up for the first quarter was the highest first quarter total in nearly three years. The City accounted for 50% of Central London take-up as transaction levels reached a near record 2.2 million sq ft, while take-up in the West End and the Docklands was above the long-term average. However according to Jones Lang LaSalle, occupier demand fell 18% across London as new requirements could not fully offset those withdrawn or lost to take-up. This lack of replacement demand represents a downside risk to the market recovery. Rents in Central London are still 4% lower than a year ago, although on a quarterly basis the CBRE Central London prime rent index rose by 6% during Q These trends are reflected in prime headline rents which increased over the quarter to per sq ft in the City and per sq ft in the West End. These increases in headline rents are however tempered by the incentive packages, including substantial initial rent free periods, which are still required to close deals. Central London office availability has fallen significantly over the last 6 months as tenants take advantage of these incentives to upgrade or consolidate their space and occupiers withdraw sublease space from the market in anticipation of future expansion. Knight Frank state that there is now 20.4 million sq ft available across Central London; 17% lower than the peak of 24.6 million sq ft in Q Increased take-up and a drop in speculative construction have resulted in the volume of available new and refurbished space reducing to 5.5 million sq ft, a reduction of 30% over the last 9 months. 2

3 Development activity fell for the eighth consecutive quarter as the lack of available development funding continued to prevent new schemes commencing speculatively. With 2009 marking the peak of the development cycle, development completions are expected to decline this year to only 4.1 million sq ft in 2010, compared with 6.5 million sq ft last year. Only 1.3 million sq ft of completions are scheduled for 2011, which would make it the lowest level on record. Five deals of over 100,000 sq ft completed in Central London during March In the City, law firms dominated with Pinsent Masons committing to 181,700 sq ft at 30 Crown Place, EC2 and Stephenson Harwood leasing 128,500 sq ft at 1 Finsbury Circus, EC2. In the West End the two largest leasing transactions were both north of the Euston Road with Aegis Group taking 117,400 sq ft at Regents Place 1, NW1 and The Royal College of General Practitioners committing to 107,600 sq ft at Euston Xchange, NW1. Investment Market Activity Central London investment volumes in the first quarter have been reported in the range 1.2 billion to 1.7 billion. This is some 40% lower than the last quarter of However higher prices have tempted more sellers to bring investment stock to the market and transaction levels should increase in the second quarter, although the policy changes being announced by the new coalition Government may affect investor confidence and could restrict activity in the weeks ahead. Overseas buyers, encouraged by the weakness of sterling and low interest rates, are still active with CB Richard Ellis reporting that foreign buyers accounted for 60% of the first quarter s transactions, compared with 73% during Overseas investors have been most active in the acquisition of buildings in excess of 100m. Middle Eastern and German investors maintained their strong interest in the Central London market they accounted for 40% and 12% of total investments respectively. Domestic investors, including the UK property funds, were more active in the smaller lot sizes and accounted for 40% of all transactions. Prime office yields have continued to fall. In the City, prime yields are in the range 5.50% to 5.75%, and in the West End prime yields are around 4.50%, a 150 basis point fall over the last 12 months. Prime yields are unlikely to move out in the immediate future as prospects for Central London rental growth improve with incentives on new leases reducing and the supply pipeline tightening over the next two years. Outside London and in the regions, yield compression has been less marked and there are opportunities for cash buyers to obtain higher yields and to acquire properties at close to replacement cost where there are leases with less than 10 years remaining. Outlook As we reported in January, there is more optimism that the recovery in commercial property capital values is well established and the prospects of future Central London rental growth are now much clearer than a year ago. However, property yields are now much closer to the levels seen during the boom years of 2006/7 and are likely to remain low while investor appetite remains strong. Offsetting this, capital values are some 20% lower than at the peak of the market due to lower real rental values and the weakness of Sterling makes UK property significantly more attractive to investors whose currencies are linked to the US dollar. 3

4 Doubts still exist as to how strongly the UK economy will perform over the remainder of 2010 and the inevitable reduction in public sector spending will take some steam out of both the residential and commercial sectors for some years to come. For this reason, it is wise not to get carried away by the present levels of market activity. Investment decisions must be made based on sound property fundamentals and investors should take a longer term view if they are to be successful. Recent UK Investment Transactions City of London 100 New Bridge Street, EC4 German closed-ended fund manager HIH Global Invest completed the purchase of 100 New Bridge Street for million to show a net initial yield of 6.17%. The 167,272 sq ft property, developed in 1992, is located in the western part of the City of London near Blackfriars Station. The offices are fully leased to Baker & McKenzie until Retail tenants in the building include Boots and Pret-a-Manger. South Bank 65 Southwark Street, SE1 Rockspring completed the sale and short term leaseback of this office building from Deutsche Bank for 8.6 million deal has now exchanged. Rockspring plans a substantial refurbishment and extension the building with the aim to release it to the occupational market in Southwark Street, SE1 Freehold 15,343 sq ft modernised office building sold for 5.05 million to show a net initial yield of around 7.0%. The building was mainly leased to 2 tenants with lease expirations in April 2012 and December 2014 (with a tenant s option to terminate at any time on 9 months notice). The balance of the space was subject to a rental guarantee from the seller. West End Victoria House, Southampton Row, WC1 The largest office deal in London s West End market since 2007 completed in February with the acquisition by M1 Real Estate of the art deco Victoria House on the east side of Bloomsbury Square for 175 million 33 Charlotte Street, W1 Standard Life Investments purchased this property from Capital & City for 19.1 million to show a yield of 5.6%.The building is multi-let to six tenants with an average unexpired lease term of 7.5 years and includes offices, three restaurant units and residential accommodation. 111 Strand, WC2 Aviva Investors purchased this property in London s West End for 35 million reflecting a net initial yield of 5.1%. The property is held from the Duchy of Lancaster on a long lease with 140 years remaining at peppercorn rental. The 37,998 sq ft building, completed in 2003, is multi let to five tenants with 85% of the office space leased to global private equity and investment advisory firm, CVC Capital Partners for a further 9 years. 4

5 12 Curzon Street, Mayfair W1 A private investor purchased 12 Curzon Street in London s West End for 10.2 million. The 12,300 sq ft building comprises offices and residential space and was sold by a private Italian vendor. 26 Dover Street, London W1 Freehold recently refurbished 5,586 sq ft office building, leased to Investec Group (UK) Plc until December 2017 at 300,000 per annum exclusive, was sold for million to show a net initial yield of 4.25%. London Suburbs Eagle Court, Vine Street, Uxbridge, Middlesex West Sussex Pension Fund purchased this modern 13,703 sq ft office building leased to Neptune Oriental Lines for a further 7.75 years for million to show a net yield of 7% Capital Court, Uxbridge, Middlesex Orchard Street Investment Management purchased this prime 57,000 sq ft office building, mainly let to Manpower UK and solicitors, Iliffes Booth Bennett with average lease lengths of over 12 years, for 19.2 million to show a net initial yield of 6.6%. South-East Regional Sales Berkeley House, 19 Portsmouth Road, Cobham, Surrey Freehold 1990s headquarters office building of 17,850 sq ft leased to Berkeley Commercial Investments Ltd and guaranteed by The Berkeley Group Plc until 27 April 2020 was sold to the occupier for 6.15 million reflecting a net initial yield of 6.5%. Meadows Business Park, Camberley, Surrey Mountgrange Investment Management bought this business park, totalling 140,000 sq ft of offices and 16,000 sq ft of storage space, for 23.5 million reflecting a net initial yield of 8.75%. The property is around 80% leased with some suites remaining vacant from when the development was completed in The purchase price was however below replacement cost. One Guildhall Square, Southampton, Hampshire Southampton City Council has bought a six-storey, 72,747 sq ft office development it is due to occupy on completion this year for 25 million reflecting a net initial yield of 5.7%. Apart from the Council, which had signed a 40 years lease, the remaining space had also been pre-let to Capita Business Services on a 12 year lease. Contacts Peter Dewar Rob Cregeen Dick Grillo

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