Poor relation strikes it rich

Copyright: David Lawson - Management Today  2004


Suddenly, property is sexy. That might seem obvious from the way house prices are soaring but behind the headlines a frenzy is also sweeping through office blocks and warehouses. Few notice because it has little impact on occupiers. Most  are tenants, and rents are remarkably stable. In fact anyone taking space now might be asked less than neighbours agreed a few years ago.

  The paradox can be confusing. Surely property companies should be City darlings rather than a minor sideline? And why should occupiers be so unhappy that they have asked the government to intervene?

   Commercial property investment has long been the poor relation to shares and gilts. A combination of the stock market crash and plunging interest rates has turned this on its head. In the past, investors would pile in when rents were soaring. Now they are happy they can borrow so cheaply that profits come in even when rents are stable. Returns are far outstripping other assets.

   Big developers are reaping few rewards, however, because building has been in the doldrums since the dot.com crash and post-9/11 global downturn. Some are clearing out old stock but  main beneficiaries are pension funds and insurance  companies, which sold around £1.5bn of  buildings last year. That is ironic, as they have bought the lion’s share of property for decades and still own the vast majority of Britain’s business accommodation. But something had to fill the hole left by decimated equity holdings and raise liquidity levels to meet a tougher new minimum.

    They have little trouble unloading to a ravening pack of foreign and private buyers. German funds alone bought almost £3bn  last year, according to DTZ Research, with Middle East and French buyers not far behind. Meanwhile private investors have gobbled up around £10.5bn in the last three years, says consultant Lambert Smith Hampton.  Some of these  figures overlap: for instance, £1.5bn flowing in from Ireland came from private buyers.

  Foreigners like the UK’s high yields of around 5 to 9%, particularly as they are linked to uniquely long leases with upward-only rent reviews. Private buyers are  entranced by the yield advantage over equities, linked to the fact that they can borrow at interest rates well below returns.

    An extra boost has come from property trusts and partnerships set up over the last few years to reduce tax burdens but this is only a taste of the potential boom when new vehicles proposed in the Budget called property investment funds [PIF] are launched. They could prove attractive for smaller investors who have poured £40bn into housing over  the last eight years, according to FPDSavills, and are now looking for a move into commercial property. It could also be the last straw for traditional public property companies. Many have gone private and even the biggest are considering re-launching as PIFs.

  But key factors which makes UK property so attractive are under threat. Occupiers have persuaded the government to consider banning the rule that rents always rise after the traditional five-year review. And they are forcing landlords to offer much  shorter leases.

   This illustrates a fundamental flaw in the sector, where the product has been driven by the manufacturer rather than the consumer. Top commercial property is built to ‘institutional standards’  covering factors including floor sizes and air conditioning that restrict choice and raise tenant costs. Imagine if the car industry still followed the Henry Ford rule that buyers ‘could have any colour as long as it is black’  - and would be charged extra for the privilege.

  But change is happening. Peter Kershaw has been involved in some of the world’s biggest developments such as London’s Broadgate and Asia’s massive Petronas Towers but now heads HQ, one of Europe’s leading  suppliers of serviced offices.  These offer fully-fitted space for as little as a few months and will grow into a major slice of the sector. ‘Modern business methods mean occupiers need the flexibility to move in and out of premises quickly,’ he says.

   Reformers are also helping shift the balance to occupiers by demanding better buildings. ‘It doesn’t matter how much money a development makes. If it doesn’t work then it is a failure,’ says Richard Kauntze, chief executive of the British Council for Offices, a pressure group of developers, architects and occupiers.

   BCO pressure to make buildings match occupier needs means recent developments are greener and cheaper to run – a critical fact when leases dump most costs onto tenants. But he admits there is still a long way when research shows occupiers still feel they are getting poor service. Making workplaces more amenable to staff is critical. ‘After all, they make up 85% of business costs.’

  Giant ‘institutional standard’ floors may be sacrificed, as studies show access to daylight raises staff morale and productivity. In Germany, no-one can be seated away from a window and enlightened investors fear similar intrusion of regulations could follow in the UK – just as with lease terms - unless the industry changes its spots.