Copyright: David Lawson/Financial Times November 1999
Ask any top real estate consultant how much private investment is flowing into London and watch his eyes cloud over. 'Insignificant,' says one. 'This city belongs to big institutions.' 'Check the auction rooms,' says another, conjuring a picture of dealers fighting over backstreet offices and suburban shopping.
To an extent, they are right. Prime City offices and West End shops are what makes the capital sexy and with lot sizes ranging upwards of £50m, all but the biggest funds and property companies have been excluded. But this is a thin slice of the real estate which makes up the bulk of any city. Below this, private buyers have been rampant over the last couple of years. The boom stems from a combination of buoyant markets, friendly lenders and a disenchantment with other forms of investment.
The market was fired when interest rates dropped last year. 'You could borrow at 5 per cent and get an immediate yield of 7 to 8 per cent. It was a no-brain investment,' says Richard Auterac of Jones Lang LaSalle. This brought in a swarm of newcomers, not just from the UK but Ireland, Israel, the Middle East and America. As rates creep back up, brains come back into the equation and the market has cooled. But it has not frozen.
'Long-term fixed interest rates are still relatively low, allowing private investors to raise capital cheaply,' says Jeffrey Selwyn, the veteran finance specialist at Allsop Selwyn whose eyes brighten rather than cloud at the first mention of his core market.
The right figures are irrelevant unless lenders are willing to listen, however. Memories of the crash have faded, enticing not just UK banks and building societies but the big German funds to loosen their purse strings. Property lending rose for five successive quarters, reaching more than œ41bn at the end of June, and has only slightly eased as interest rates rise, according to consultants GVA Grimley.
Much of this will have poured into property companies and some will be aimed outside the south-east. But the sheer size of the London market means most will have been absorbed by the capital. And the easing of terms which fuelled this boom has brought in new buyers to challenge listed real estate groups.
Real estate is clawing back ground lost to other forms of investment. Returns on long-term cash deposits have plunged, pension annuities look sickly and investors are increasingly nervous that stock markets can continue to produce past returns. Direct property, on the other hand, remains buoyant. Knight Frank is predicting total returns of 12-13% over the next three years, driven by a hardening of yields and continuing rental growth.
This kind of financial logic is not new. 'If you go back 40 years it was the norm,' says Mark Houslop, director of DTZ Debenham Thorpe Investment. It was only when inflation became an accepted fact of life that institutions took over the market as a hedge. Now the pendulum is swinging back, as funds pull out and private buyers swarm in.
London is a focus for investors because it has felt a disproportionate benefit from national economic recovery. Employment grew by more than 3 per cent over the last year compared with 1.2 nationally, feeding through to tenant demand for commercial property. Average rents climbed more than 2 per cent between the second and third quarters of this year and soared 6 per cent in the year to September, says GVA Grimley. This has brought investment levels back up to £1.7bn compared with £4.5bn in the whole of 1998, says DTZ Debenham Thorpe.
The impact of private money can be seen in its natural habitat - the auction room. Allsop & Co has seen its sales rise from £230m in 1998 to £300m in the first nine months of this year, most of it property within the M25. Jones Lang LaSalle has sold up to £100m through salerooms in the same period and the proportion of private buyers has risen from 25% to 80% in five years.
Neil Mackilligin of Allsops says this enthusiasm has spilled into a mass of deals which go largely unreported because most buyers do not seek publicity or need to issue stock exchange notices. Some have been too big too hide, however.
When 115,000 sq ft of offices and shops on the corner of Kingsway and High Holborn came on the market, it was taken for granted that an institution or public company would step in. But a private UK won the bidding at œ118m. A Middle East consortium paid £140m for BP's HQ in the City and the private US Witkoff Group some œ180m for the landmark Shell-Mex House on the Strand.
The logic behind these deals is no different in principle from dozens of other much smaller transactions taking place across the capital. Selwyn, who organised the finance for the High Holborn transaction, says the initial income yield matched interest payments, so it immediately washed its face. The 41 tenancies also offer scope for further value through changing tenant mix, rent reviews or redevelopment.
This kind of project is meat and drink to larger private investors, who use management or break-up skills to add value. They are selling other property and equities or gearing up with hefty loans to buy a range of London property ranging from warehousing to modern offices around the M25, says Selwyn. Smaller buyers are more interested in good covenants with long leases. They are taking properties of up to œ1m pounds being released by institutions and listed property companies.
Rising interest rates have weakened the flow of private investment. They made up only 3.1% of West End purchasers in the three months to September compared with 11.6% in the first quarter, says Jones Lang LaSalle. But as the economy improves, risk of voids and defaults has fallen, cutting the risk premium on real estate. Investment yields have softened much less than might have been expected.
While 'no brain' investments may be a fading memory, this means private investors remain an important part of the London property market, says JLL research associate director Sue Foxley.