UK Property Market London & South East October 2011 Economic Background In our July market update, we reported that the recovery in the UK economy was proving to be much slower than expected. Since then, we have seen a substantial slowdown in world markets, most noticeably the USA and the Euro zone, where agreement has still not been reached by the wealthier northern European members on how to support sovereign debt of the weaker southern European economies. Britain's economy grew faster than expected in the third quarter but the decline in the manufacturing sector has accelerated and economists are warning the UK could be on the verge of recession. GDP expanded 0.5% over July to September from the previous quarter, according to the Office for National Statistics. Economists had been expecting at least some rebound from growth of just 0.1% in the second quarter and the consensus forecast was for 0.4% growth in the third quarter. GDP growth predictions for the whole year have continued to be downgraded as the year has progressed. The Ernst & Young ITEM Club revised its forecast of UK GDP growth down to 0.9% for this year, followed by 1.5% in 2012 and 2.5% in 2013. The dangers of interest rate hikes in the near future have diminished as the Bank of England s Monetary Policy Committee voted at their October meeting not only to maintain the historically low Base Rate of 0.5% but announced a further round of 75 million of quantitative easing. The ITEM Club warns that this extra quantitative easing is unlikely to have much effect, and instead suggests a number of tax and spending measures which could help pull the UK economy back on track and provide a safety net if things go wrong. The Chancellor of the Exchequer has to date resolutely stuck to his Plan A for cutting the national debt but his Autumn Statement due to be delivered on Tuesday, 29 November 2011, will be keenly awaited to see if the Government can provide any new initiatives to promote a return to growth.
Despite the slowdown in the economy UK inflation rate has increased again with the Consumer Price Index (CPI) currently at 5.2% up from 4.2% in June and the Retail Price Index (RPI) is at 5.6% up from 5.0% in June. Recent increases in gas and electricity prices will keep the CPI high this autumn at close to 5% in the final quarter of this year), but it is forecast to fall back below 2% by the final quarter of 2012. Unemployment has moved up again, reaching 2.57 million in September, as private sector expansion has slowed and public sector cuts have taken effect. The forecast shows employment on moving up to 2.7 million in 2013, but falling back below 2.5 million in 2015 as growth and the demand for labour are expected to pick up. The latest UK Housing Market survey from the Royal Institution of Chartered Surveyors (RICS) states that although 23 per cent more surveyors report falling prices, threequarters of those who confirm falling prices put the drop at no more than two per cent. Regionally, only London continues to report rising prices. The RICS survey confirms the October analysis from Halifax, Britain s biggest lender, which showed an annual fall of 2.3 per cent to the end of September to an average UK house price of 161,132, against 162,307 in September 2010. Halifax suggests little prospect of change for the rest of this year, with low interest rates and a marginal rise in employment over the past year continuing to support the market but demand has been hard hit by higher inflation, increased taxes and rising energy bills. 3 month LIBOR has increased marginally over the last three months and is now in the region of 0.95% but with receding risks of any imminent rise in Base Rate, SWAP rates have continued to fall, with 3 year SWAPs at only 1.44% and 5 year SWAP at 1.84%. These rates are down by 57 bps and 84 bps respectively since the beginning of the year. Despite these low rates the levels of new lending on commercial property continue to be restricted. UK Property Market Trends The IPD Quarterly Index for UK property as a whole showed total returns of 9.3% for the year ending 30 September 2011. UK offices remainder the strongest performer with a 12 month total return of 10.0% to the end of Q3. In the third quarter UK offices produced a total return of 2.1% made up of 1.4% of income and 0.7% of capital growth. Commercial property delivered a total return of 1.9% for the three months to September, despite the wider market turmoil that saw -13.5% wiped from the value of equities in the same period, based on comparison of the IPD UK Monthly Index and FTSE All Share Index. UK property capital growth remained steady at 0.1% in September, mainly due to continued strong performance in the Central London office and retail markets. Despite concerns over a pricing bubble in the Central London office market, growth continued in September at 0.6%. However, IPD reports that despite the wider economic risk, investors are starting to look outside the centre to find more competitive prices. Offices in the Rest of London saw positive growth for the fifth consecutive month, of 0.5%. For the year to date, offices are the strongest performing sector with total returns of 7.5% and capital growth of 2.9% according the figures published by CB Richard Ellis. Over the last three months UK offices have shown annualised rental growth of 2.1% and capital growth of 2.2% lead by Central London offices which showed annualised rental growth of 5.8% and capital growth of 5.0%. Prime yields across all sectors of the UK property remained stable over the last three months.
According to a recently released report by the Property Industry Alliance, the number of overseas investors directly investing in UK is growing rapidly, as property investment strategies become more global. As at the end of 2010, foreign owners are now the second largest class of owner with 71 billion of property assets representing 23% of the UK commercial property market and are poised to overtake UK institutions to become the largest. UK institutions currently hold 75 billion of property assets or 24% of the UK market. Collective investment schemes (managed funds, property unit trusts, limited partnerships etc) with 56 billion or 18% of the market have also grown substantially, reflecting increased interest in the asset class from smaller institutional and retail (individual) investors, overseas institutions, and a shift in personal savings habits towards unit trusts. Retail investors put an extra 1.8bn into such schemes in 2010. Nearly half UK property is owned for the purpose of providing returns to UK pension funds and other personal savings schemes, especially when account is taken of the use of REITS and listed property companies in such schemes. Central London Office Market Both capital and rental growth have slowed compared to the 12 months to June 2011, when Central London offices saw total returns of 18.4%. Over the current year to September 2011 Central London offices showed total returns of 10.2% to which capital growth contributed 6.0% and rental growth 4.9% according the figures published by CB Richard Ellis. Prime City office yields have moved out marginally in Q3 2011 by 0.25% to 5.25% while prime West End office yields remain at 4.0%, the level reached at year end 2010. Central London office yields are unlikely to ease during the last two months of 2011, although at least 10 large office buildings in the City and Docklands with an aggregate value of over 4 billion have recently been brought to the market, which will prove a litmus test for prime City office yields. A total of 2.2 million sq ft of office space was leased across the West End and City and Docklands during Q3 2011, according to research by Cushman & Wakefield. This figure is up from Q2, when take-up totalled only 1.4 million sq ft. The agent reported that leasing activity in Q3 was 15% down on the same period in 2010, as the global economic turmoil filters through to all sectors of the economy. TMT (Telecommunications, Media and Technology) is the strongest occupier sector, accounting for more than one-third of takeup in 2011 to date. Despite this the agent expects annual take-up to be around the fiveyear average level. Grade A office availability remained flat across Central London and take-up fell in during the third quarter of the year, according to a report by Colliers International. The agent said office availability has remained at 7.7% of total supply; the first time since Q3 2009 that quarterly vacancy rates have not fallen. New and refurbished space rose slightly by 5%. The City vacancy rate remains unchanged at 9.5%, suggesting a steady absorption of space albeit with a limited supply of new space. In the West End, new and refurbished space declined by 3% and is now down by 33% in past 12 months. In Mayfair, total availability has fallen sharply by 43% in the past 12 months. Anticipated development completions for the remainder of 2011 across London are expected to total 292,000 sq ft, bringing annual completions to 1.6 million sq ft, compared to a 10-year average of 5.4 million sq ft. The research also revealed that in the City market, 65% of space completing in 2011 remains vacant, compared to the West End market, where 75% of space completed in 2011 to date is either let or under offer.
City of London Core City office availability has risen over the last quarter to 7.12 million sq ft which is equivalent to a vacancy rate of 11.9%. This is approaching its 2009 peak and is higher than the vacancy rate in all other Central London submarkets with Fringe City at vacancy levels of 8.3%, lower than it has been at any time in the last 5 years. Prime Core City of London office quoting rents are in the range 55.00 per sq ft and 59.50 per sq ft, while second hand space has much lower quoting rates averaging 34.00 per sq ft. City leasing activity during the summer quarter has only picked up slightly with only 660,000 sq ft leased from July to September. The largest deal in Q3 was 31,500 sq ft of second hand space leased to management, engineering and development consultancy, Mott MacDonald at 10 Fleet Place, EC4. City lettings in new or refurbished space included 17,500 sq ft leased at Arab Investment s 60 Gresham Street and a number of lettings totalling 75,000 sq ft at 200 Aldersgate Street, where Helical Bar were brought in as project managers 18 months ago to organise a refurbishment to reposition the building to suit current occupiers demands. The largest office space under offer in buildings under construction at the end of September remains the 191,700 sq ft under offer to AON at The Leadenhall Building, EC3 (known as the Cheesegrater on account of its wedge shape with each floor raking back on the southern side from the one below, which allows it to taper away from St Paul's Cathedral and reduce its profile from protected viewing points. West End Office supply in the West End has fallen 25% since the beginning of 2011, from 6.2m sq ft to 4.7m sq ft, which equates to a vacancy rate of 4.6%, based on research by Cushman & Wakefield. Around 220,000 sq ft of space was completed in five buildings in Q3 2011, including 1 Kingsway (105,000 sq ft), the largest scheme to complete. West End demand totals 4.3 million sq ft, up from 3.1 million sq ft in January 2011. TMT companies account for just under half of all active demand. The media sector accounts for more than 1 million sq ft of enquiries, with technology companies adding a further 826,000 sq ft. A number of companies are considering longer-term moves, with lease terminations or break clauses remaining the main driver of such relocations. Cushman & Wakefield say that a lack of good-quality space is supporting rental growth in the key submarkets of Mayfair and St James's, Soho and Covent Garden and Victoria, where rents have seen double-digit growth over the last 12 months. They say that further rental growth is anticipated in prime locations, although growth will not be widespread across all submarkets and the pace of increase is forecast to slow into 2012. There were two major prelets in the West End in Q3 2011. Debenhams have agreed to take 154,000 sq ft at Regent's Place, representing 40% of the office space under construction by British Land. Camden Primary Care Trust have committed to take 150,000 sq ft at King's Cross Central. In Mayfair and St James's only one deal of over 10,000 sq ft has been signed during the past year at more than 90 per sq ft. West London & Thames Valley A recent survey of offices in London s Western Corridor, by Jones Lang LaSalle reported improving activity with decreasing supply and increased occupier demand and investment volumes. The survey covers the triangular area extending out from Chiswick &
Hammersmith in West London towards Reading, Berkshire along the M4 and bounded by the M40 to north and by the M3 to the south. Occupier demand increased 51% in the first half of 2011 compared to the same period last year, with 3.2 million sq ft of active requirements although this has yet to feed through into leasing volumes, with activity for the period down 20% on the same period in 2010. Despite this lower leasing activity, vacancy rates have fallen with Grade A at its lowest level since 2008 at 5.9% and in West London Grade A supply fell to 3.3%, its lowest level in nine years according to the study. JLL also report that investment activity picked up over the first half of 2011 with 805 million traded which is in line with five year average levels. This total was however skewed by the purchase of Chiswick Park by Blackstone for 480 million. UK investors who have been priced out of the London market accounted for about 15% of investment activity and an increased appetite from international investors accounted for 568 million of transactions. Looking forward supply shortages of Grade A space are expected to drive increases in prime rents in the M4 corridor. Hammersmith is expected to lead and even Bracknell and Slough, which both suffered double-digit rental falls in 2010 are forecast to see recovery over the next five years with growth rates averaging 3.5% and 4.8% per annum respectively. Investment Market Activity UK property investment transactions totalled 6.9 billion during Q3 2011 bringing the total for the year to date to 24.3 billion, according to figures from Property Data. Of this Q3 UK total, both BNP Paribas Real Estate and Knight Frank report that only 1.8 billion to 2.0 billion related to deals in Central London. Q3 investment turnover in Central London fell by 25% from the previous quarter s level and was 19% below the long-term average. Although there were a similar number of Central London transactions in each of the last two quarters, the Q3 average transaction size was far smaller than in Q2. A lack of investment stock has also constrained investment activity in the City where turnover for Q3 was down substantially at only circa 1 billion and for the year to date there have been no investment transactions in Docklands. However, there has been a surge in large City and Docklands office investments brought to the market within the last 6 weeks, which could result in a bumper fourth quarter although it will test the resilience of the property market in the face of other external economic pressures. Against the lower City investment activity, surprisingly West End investment activity rose for the third consecutive quarter in Q3 2011, to just under 1 billion, a 15% increase over the previous quarter. Much of this increased turnover was however due to the purchase of Sanctuary Buildings by Tishman Speyer for 175 million and the purchase of 11-12 St James s Square by the Malaysian Employees Pension Fund for 148 million. Outside London, both UK and overseas investors have been active in outer London and the south-east where higher yields can be obtained for modern offices leased to strong corporate tenants reflecting the lower anticipated rental growth in the immediate future. Other UK regional office markets saw an increase in investment volumes in Q3 2011 driven partly increased availability due to distressed asset disposals. Volumes are still lower than in 2010 as investors remain cautious about the UK regional office market.
Outlook The UK economy has been adversely affected by the slowdown of other world markets and the sovereign debt crisis which has engulfed its European neighbours. The UK Government has been sticking to its planned spending cuts, although in recent weeks there have been announcements of infrastructure projects, including the construction of two new power stations, being brought forward with the aim of kick starting growth in the regions. Inflation continues to run at over double the target rate, but despite this, the financial markets are not expecting any increase in Bank of England Base Rate for some time to come and SWAP rates remain at historically low levels. BNP Paribas Real Estate s current central forecast is for total UK property returns of 7.8% in 2011 only half of that produced in 2010 with a further decrease next year as the economic pain continues, producing returns of only 4.1%. However, they forecast improvement in 2013 to 9.3% and later years producing average annual returns of 9% for the period 2011-16. These forecast returns apply to UK property as a whole, but we believe that they can be exceeded by careful stock selection. Although, capital growth can be achieved over the longer term, buying at low yields in the anticipation of rental growth will not always be rewarded. There is no substitute for current income. In our view modern buildings in outer London, the south-east and the larger regional cities, leased to strong corporate covenants are more realistically priced than some trophy assets. Care needs to be taken that the capital values are a fair reflection of the underlying quality of the real estate. Market conditions continue to favour cash buyers capable of taking a five to seven year view and prepared to actively manage their investments to realise their full potential. Recent UK Investment Transactions City of London 99 Bishopsgate, EC2 UK REIT Hammerson plc, which has owned a long leasehold interest in the property since its reconstruction in 1994, paid 100 million for the 999 year superior leasehold interest previously held by UK insurer Prudential. The 26 storey building provides 339,000 sq ft of offices which will be refurbished by Hammerson as existing tenants vacate. Vintners Place, 68 Upper Thames Street, EC4 In another leasehold transaction, Pramerica Real Estate Investors, purchased the 128 year ground lease on Vintners Place, for its UK Ground Lease Fund for 10.5 million from Atlas Capital Group. The freehold of this 265,000 sq ft office building is owned by the Worshipful Company of Vintners. St Andrew s House, 18-20 St Andrew Street, EC4 West Midlands Pension Fund purchased this 51,000 sq ft 1980 s office building for 25 million in partnership with ING Real Estate Investment Management. The price reflects a yield of 6.6%, and the building is leased to PWC until September 2013 but under-let floor by floor providing an asset management opportunity. The price reflects a capital value of 490 per sq ft. Atlas House, 1-7 King Street, EC2 Global Asset Management bought a part-vacant City of London office building for 19.5 million for its UBS South East Recovery Fund. The property comprises 43,090 sq ft and is a grade II-listed building dating back to 1836. The basement, ground and first floors are let
to Barclays Bank for a further 12 years. The remaining space, which is vacant, will be refurbished and available to let in early 2012. The price equates to a capital value of 452 per sq ft. Midtown W Hotel, Leicester Square, WC2 This hotel, retail and residential investment was sold by Irish developers, McAleer & Rushe to a Quatri investor for an estimated 200 million. The Freehold building comprises a 192 room luxury hotel leased to W Leicester Square Limited and operated by Starwood Hotels, a retail store of 34,750 sq ft leased to Mars Chocolate UK Limited and 11 luxury duplex apartments with a total area of 16,800 sq ft. The rent roll equated to 7.7 million per annum producing a net initial yield of circa 3.64% before income from the apartments. 200 & 214 Gray s Inn Road, WC1 The Great Ropemaker Partnership, a 50:50 Joint Venture between Great Portland Estates and the BP Pension Fund, has purchased these properties from an affiliate of Beacon Capital for 132.75 million. 200 Gray s Inn Road is a 246,500 sq ft office building leased to four tenants including Carlton Communications and ITN at 8.42 million per annum. The price equates to a capital value of 455 per sq ft. 95 Aldwych, WC2 Private family trust Arbel Holdings purchased the 30,394 sq ft at 95 Aldwych, close to London s Covent Garden, for 15.9 million, reflecting a net initial yield of approximately 6.5%. Tenants at the multi-let property include Holmen Paper, Peachey & Co, Nimsoft and Randstad CPE and the average rent is 35.47 per sq ft. The price reflects a capital value of 523 per sq ft West End 187-195 Oxford Street, W1 Irish property entrepreneur Paddy McKillen sold this retail building to an overseas investor for around 53.5 million reflecting a yield of around 4.5%. The building was leased to Dorothy Perkins, which last month agreed to assign the lease of the 10,000 sq ft store to Boots. 23 Grosvenor Street, W1 James Caan, of Dragon s Den fame, has sold this 5,012 sq ft long leasehold office building with the benefit of vacant possession to a private overseas buyer for a price in excess of 8 million representing a capital value in the region of 1,600 per sq ft. Sanctuary Buildings, Great Smith Street, Westminster, SW1 Tishman Speyer purchased this 227,100 sq ft office building from Vico Capital for 175 million, reflecting a net initial yield of 5.78%. The property is leased to the Department of Education until 2017. The sale price equates to 770 per sq ft. 11-12 St James Square, SW1 The Malaysia Employees Property Fund acquired this 81,800 sq ft office building from D2 Private for 147.5 million, to show a net initial yield of 5.66%. The property includes modern office block behind the two Georgian Grade II Listed buildings fronting the square. The sale price reflects a capital value of 1,800 per sq ft. One Hyde Park, Knightsbridge, SW7 The 8,950 sq ft McLaren showroom on the ground floor of this luxury residential development is reported to have been sold to a Hong Kong businessman for just under 11.5 million reflecting a net initial yield of about 3.3% and a capital value equivalent to
1,285 per sq ft. The McLaren store is let on a 15-year lease and is one of three retail units at the scheme, which include the flagship Rolex store recently sold to Russian investor Grigory Guselnikov for more than 13 million, reflecting a yield of just under 3%. South Bank Shell Centre, Southbank, SE1 Canary Wharf Group and Qatari Diar are reported to have paid 300 million for a 999-year lease of the 5.25-acre site, excluding the 27-storey Shell Centre tower. Shell's low-rise wing adjacent to the tower will be demolished resulting in about 1,700 Shell staff out of the company's 4,000-strong London workforce being relocated temporarily to Canary Wharf and the Shell Mex building in the Strand before moving back into the building in about five years. 169 Union Street, SE1 Oxygen Asset Management in a joint venture with South African clients purchased the London Fire Brigade s headquarters in Southwark for around 50 million, representing a yield of around 5.7%. The 1905-built former Post Office sorting office, which had been comprehensively refurbished in 2000, comprises 117,392 sq ft of offices let to the London Fire and Emergency Planning Authority for a term of 17 years from March 2010 without a break. The price reflects a capital value of 426 per sq ft. Outer London Hayes Business Park, Uxbridge, Middlesex Universities Superannuation Scheme bought the 182,000 sq ft Hayes Business Park in Uxbridge, the home of United Biscuits and Heinz, out of receivership for 56.5 million, representing a net initial yield of 9.1%. The office park originally developed Tishman International comprises three self-contained office buildings, which are let to United Biscuits, Fujitsu Europe and Heinz with leases expiring in 2020. The price reflects a capital Value of 310 per sq ft. South-East Regional Sales Tesco Distribution Unit, Flex Meadow, Pinnacles West, Harlow, Essex London & Stamford Property exchanged contracts to purchase this 273,115 sq ft distribution warehouse for 22.9 million, reflecting a yield of 7.5%. The property is leased at a current rent of 1,817,000 per annum for a further 12.5 years to Tesco, which uses the facility to distribute to its stores in London and the South East. The price is equivalent to 85 per sq ft. Phase 100, Cambourne Business Park, Cambridge A modern office park providing 103,000 sq ft of offices in three buildings leased to serviced offices provider, Regus (expiring December 2015), Convergys (exp. January 2021) and Citrix (exp. September 18) was purchased by Alpha Real Capital from Legal & General for 21.5 million, reflecting a net initial yield of 8.75%. The price is equivalent to a capital value of 209 per sq ft overall. Quadrant Court, Guildford Road, Woking, Surrey This 71,000 sq ft office building, constructed in 1986 and refurbished internally in 2005, was sold to a private investor 17.25 million at a net initial yield of 7.27%. The entire building is leased to Surrey County Council for a further 10 years at 18.67 per sq ft. The purchase price reflects a capital value of 243 per sq ft.
40 Clarendon Road, Watford UK institutional investor, Threadneedle purchased this 49,393 sq ft office building, leased to Total Oil until December 2014, for 9.4 million, reflecting a net initial yield of 9.98% and a capital value of 190 per sq ft. Thorpe Park, Peterborough, Cambridgeshire A private investor acquired this 49,000 sq ft office building for 7.7 million from Northgate Arinso, subject to a new 15 year leaseback to the seller at 12 per sq ft, to show a net initial yield of 7.5%. The purchase price reflects a capital value of 157 per sq ft. 140 Cambridge Science Park, Cambridge This 26,238 sq ft office building leased to Jagex Limited, an independent developer and publisher of online games for a further 5.5 years at an annual rent of 525,000 per annum was purchased by Mayfair Capital Partners for 6.35 million, to show a net initial yield of 7.8%. The purchase price represents a capital value of 242 per sq ft. Omega Park, Southmead Industrial Estate, Didcot, Oxfordshire Ignis Asset Management purchased this 126,600 sq ft. industrial estate, on behalf of its UK Property Fund, for 9.4 million, reflecting a net initial yield of 7.83%. The estate comprises three warehouses leased to Jewson, Pirelli and Marston Books at rents totalling 799,142 per annum. The price is equivalent to a capital value of 74 per sq ft overall. Other Regional Sales Tesco Supermarkets, Quinton in Birmingham, Ludlow in Shropshire and Market Deeping, near Peterborough, Lincolnshire Legal & General Property has bought three Tesco supermarkets in a 46.6m sale-andleaseback deal. It has bought the three supermarkets, ranging in size from 31,000 sq ft to 43,000 sq ft located in Quinton, Ludlow, and Market Deeping in the Midlands at a net initial yield of around 5.1%. The properties are let on new 20-year leases to Tesco and provide 2.4m a year in annual rental income. Citygate Court, Mosley Street, Manchester Hermes Property Unit Trust purchased this 47,000 sq ft building from Dutch insurer Aegon. The building was on the market for 8.5 million, representing a net initial yield of 8.5%. The building is let entirely to Barclays, which operates a branch at ground floor level and five floors of office space above. The bank has taken a reversionary lease on the ground floor with an option to renew its lease on the upper floors. The purchase price represents a capital value of 185 per sq ft. Contacts Peter Dewar peter@coh.eu 020 7399 2734 Rob Cregeen rob@coh.eu 020 7399 2743 Dick Grillo dgrillo@coh.eu 020 7408 1114