London Market Outlook€¦ · London Market Outlook February 2013 5 London – The Global City Drivers of Investment into the Capital London, along with New York, is the leading financial

London Market Outlook 2013

London Market Outlook February 2013

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2012 Economic Review

As we enter 2013 the outlook for the global economy remains at a crossroads, with all major regions facing significant headwinds. 2012 ended with a rise in investor sentiment as the perceived risk of the Eurozone breaking up declined. However, we remain reliant upon governments working towards a greater degree of integration in order to ease the sovereign debt crisis.

In the US, uncertainty surrounding the outcome of the Fiscal Cliff came to a head with a new tax bill passed; however, concerns remain that the recovery may be derailed as a result of upcoming talks on spending and the debt ceiling. Though the US has managed to avoid recession, the Fed recently announced the start of QE3 which involves the purchase of $40bn US treasuries and MBS, and is expected to last

through to 2014. With interest rates set to remain low, it is hoped that investors will start to take more risk and boost asset prices in the property, stock and bond markets.

Emerging markets, particularly China, will continue to drive global growth over the next few years. Whilst growth slowed in 2012 it is likely that they will achieve a soft landing thanks to various measures implemented by the government. Following five years of the worst growth performance by the UK economy since the 1920s and negative GDP numbers, concerns regarding a triple recession have heightened. Optimism remains however, that in the absence of further Euro turmoil, the worst has passed and growth is likely to resume in 2013.


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London

The safe haven destination

A fragile global economy led to strong demand for London property in 2012.

The continued fallout from the Eurozone debt crisis, concerns of weaker growth from China and fears that the US would fall off the ‘fiscal cliff’, saw investors target Central London as the primary destination for overseas investment.

Investment volumes hit five year highs as global money flow reinforced the perception of London offices and prime UK retail as a safe haven.

Over 64 per cent of money coming into the UK market was from abroad, up from 61 per cent in 2011 and 55 per cent in 2010.

According to data from the Property archive, Investors spent over £35bn buying UK offices and shopping centres, with the vast majority of the money flowing into London. While overall investor sentiment has started to show increasing signs of optimism and the desire to take on more risk, banks continue to de-lever and lending conditions have continued to tighten. These challenging debt markets have placed equity investors at a major advantage over debt-backed buyers.

Since the onset of the financial crisis, cash rich investors from Europe, Middle East and the US have spearheaded the Investment into London.

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2007 2008 2009 2010 2011 2012Overs

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Source: Property Archive


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One of the main beneficiaries of the financial crisis and the slowdown in lending has been foreign pension and sovereign wealth funds (SWF). The AUM of SWFs alone is estimated at US $5.2 trillion and continues to grow. At a time when debt finance is in such short supply, they have actively looked to take advantage of their enviable equity position.

A number of these SWFs are now so large they are unable to deploy capital in domestic markets and therefore are forced to diversify abroad, with London particularly attractive given its global appeal.

The origin of investor inflows into the UK continues to change. With Emerging Markets showing significant levels of growth over the last few years, it comes as no surprise that Asia and in particular Malaysia were behind a number of high value transactions in the City & West End.

One of 2012s highest profile deals was the purchase and £8bn redevelopment of Battersea Power Station by Malaysia’s largest pension fund. China’s sovereign wealth fund also made its first UK transaction, purchasing the headquarters Deutsche Bank.

Going forward, we are expecting to see a sharp rise in Chinese investor appetite for London property following changes to external investment rules by the Chinese government.

According to Savills the relaxation on the investment of insurance proceeds could result in up to £10bn of new inward investment into London. Given its income producing qualities, an allocation to property by institutional investors continues to steadily increase and is expected to figure increasingly in investment portfolios.


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London – The Global City Drivers of Investment into the Capital

London, along with New York, is the leading financial centre in the world, as well as a leading global city for business, the arts, education and tourism. It is a vibrant, culturally rich and fast moving city with an enormous amount to offer those looking to work, live or visit.

The London property market is extremely attractive compared to international markets. The time zone, ease of access and high quality of life has made it the number one destination for overseas equity.

According to the Investment Management Association, one pound in every three managed in Britain is done so on behalf of foreigners. As reported by the Economist, London is the world's leading centre for cross-border bank lending. It also accounts for two-fifths of global turnover in foreign exchange, more than New York and Tokyo combined, and dominates the market for bespoke interest-rate derivatives.

The transparent nature of the UK commercial property market makes it an

attractive proposition for overseas investors and occupiers. In 2010 The Jones Lang LaSalle Transparency index ranked the UK as the 3rd most transparent real estate market globally out of 81 global countries, behind Australia and Canada. London is easily accessible and is well serviced by 4 international airports; a key factor when it comes to remote ownership. The underground network is also important as it helps to link prime business areas with prime residential areas.

The structure of the UK property market is investor friendly. Leases are longer than anywhere else in the world, and most commercial leases are “triple net”, meaning the tenant is responsible for rent, building insurance and maintenance, making it easy for investors to manage their holdings remotely. It is also normal to find upward-only rent reviews in leases longer than 5 years, a useful addition in recessionary environments.


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The UK offers an investor-friendly regulatory framework and tax regime to overseas investors with no barriers to real estate ownership and the transfer of funds in and out of the country. A weaker Sterling has made UK property ‘cheaper’ for overseas investors, greatly enhancing its attractiveness.

The negative effects of the euro zone crisis have been felt far less prominently in the UK, being part of the EU, but not a member of the euro.

The perception of Sterling as a ‘safer’ currency has also led to increased levels of cross-border investments, particularly from Spanish, Italian and Greek investors concerned that they would be forced to leave the Euro. Events such as the Arab Spring also saw large inflows into sterling from the Middle East as cash rich individuals looked for somewhere safer to park their capital. As a mature market (London), property prices are relatively stable when compared with other European real-estate markets.

The desire for trophy assets should not be underestimated. The significant and somewhat rapid creation of wealth in emerging economies has also seen High Net Worth Individuals turn their attention to the UK.


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Capital Growth (%)

Year

Dec-2008 Dec-2009 Dec-2010 Dec-2011 Dec-2012

London - City -28.9 -7.4 17.0 7.3 1.1

London - Mid Town -28.0 -4.9 16.1 7.3 4.2

London - West End -25.5 -3.5 17.0 7.6 5.7

Inner London -23.1 -9.1 9.5 4.6 2.2

All Offices -26.5 -6.8 9.2 2.9 -1.4

Market Performance

The overall lack of high quality office space aligned with increasing demand, as London brushed off Europe’s economic crisis to become the world’s most coveted property market, ensured that the competition for prime property was maintained in 2012 and looks set to continue in 2013. As prime rents increased, for the first time since the financial crisis began (2008), London (West end) topped the list of most expensive office location worldwide. While the overall capital value of UK property fell by over 1%, according to IPD, London continued to show its resilience as the West End & Mid Town continued to show strong capital growth over 2012. The inflow of cash from foreign Pension & sovereign wealth funds has provided significant support for property values, as their longer term investment horizon has resulted in very stable money flows.

Source: IPD Quarterly Digest, December 2012


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In the midst of a recession, occupier demand has remained resilient despite the contraction of the investment banking sector. The City has seen a decline in take up from the finance sector but this has largely been offset by the growth in the insurance industry and rents have remained stable over the last 12 months. The West End has seemingly brushed off any concerns regarding the wider UK economy. According to IPD, as of Q2 2012, West End values were only 16% off their Q3 2007 peak compared with UK Offices, which are still down 31% from the peak. Annual take up has remained close to its long run average, partly due to a significant increase in demand from the TMT sector.

Strong overseas investor demand has led to property yields tightening. However, when compared to bond market returns of around 2%, they still remain highly attractive. Over the last 18 months the income characteristics of London property has led to it being used by some investors as an alternative to bonds. Not only is rental income from prime assets robust, it can also protect from future inflation, due to rents rising over time.

Given the strong prices and capital value per square foot achieved, it is also evident that prestigious locations and security of income are, to a number of investors, more important than net initial yields.

Source: Savills/Bloomberg


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The Road Ahead

Coming into 2013 there has been a significant increase in the level of optimism and investors have rediscovered their appetite for risk, following congress’s last minute deal to avert the fiscal cliff. The overall outlook for global growth, however, remains weak. While the US has experienced growth over the last 3 years, it has also been the weakest rebound since WW II averaging just 2.25%. The strength of the Euro zone appears to be more secure, as Draghi promised to do “whatever it takes to save the Euro” followed by the ECB’s plan to purchase sovereign bonds in unlimited quantities. However, with a number of European elections coming up and voters growing concern over austerity measures, volatility looks set to continue over the next 12 months. The UK lost its top AAA credit rating for the first time since 1978 on expectations

that growth will remain sluggish over the next few years. While UK GDP growth for 2013 is forecast to be better than 2012, it looks set to continue to disappoint relative to historic standards. Sterling fell in reaction to the Moody's credit downgrade - it has now devalued 7% against both the dollar and euro this year. A falling currency increases the chances of a rise in inflation, increasing the attraction from investors looking to hedge against this rise. The London property market now looks even more attractive to overseas investors due to the currency play. While the UK economy continues to face persistent headwinds from bank deleveraging, poor credit availability and the likelihood of a continued euro crisis, there are some bright signs. Alongside positive levels of job creation a fall in inflation has boosted the consumer.


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Riverside capital Our Outlook

We expect that the appeal of London real estate to overseas capital will remain strong in 2013. Investment volumes into London were £14.4 billion in 2012, an increase of 50% over 2011. 71% per cent of this investment came from overseas compared to a long run average of 53%. As we move into 2013 the inflow of foreign capital is set to exceed this level as investors continue to see London as a secure, long term investment. Supply in London is as tight as we, as a team, have ever known. DTZ estimate that just £1.45 billion of property is currently being openly marketed in the City compared to £3.1 billion just 3 months ago, and we are aware of 45 individual foreign investors with current requirements for Central London. Outside of these mandates there are likely to be several more. In order to gain access to the market, there is obvious potential for yields to firm further as these investors continue to outbid each other and therefore push the price of London real estate even higher. Much of the investment is flowing into offices with long leases, reflecting the appetite for stable returns and not necessarily the requirement for capital appreciation. With government bonds yields set to remain at current levels for the foreseeable future, attractive investment yields of about 5% from property aligned

with high levels of liquidity will continue to see London attract capital and help provide support for valuations.

As a consequence of the current economic environment, the lettings market was disappointing over the past year with businesses holding back on making any medium or long term commitments to new properties. Unlike previous economic downturns, there wasn’t an excessive level of building at the top of the last cycle, so with supply tight and demand set to rise over the next 12 months, we are increasingly more positive on rental values but only for the right assets in the right locations. West End, prime rents remained stable throughout 2012, and whilst there is data to suggest that the City saw some growth in 2012, this was for such a small section of the market, it is probably more accurate to look at the City in the most part as having experienced zero growth throughout 2011 and 2012, albeit there are signs growth will return in 2013. While it has been widely reported that London is now the world’s most expensive office market, Investors must remain aware that although Prime rents in the West End are at £95 psf, not every building will achieve those levels. As such, stock picking skills are as important as they have ever been. Current availability of offices in central London stands at just under 6.1% of total stock which is below the long term average of 7.4% over the last 20 years.


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A shortage of quality space in the traditional ‘media’ hub of the West End has seen companies look for more institutional grade office space that can be reconfigured to suit.

The insurance sector, as evidenced in 2012, remains a source of large requirements and is helping replace some of the demand lost by the contraction of the banking sector.

In spite of the many economic risks that are still evident, we remain extremely positive on the outlook for the London property market, and we continue to see a number of off market opportunities. These opportunities are not always dependent upon a positive economic outlook in order for us to continue making strong risk adjusted returns for our investors.

Through active asset management we will continue to look to take advantage of the many mini cycles that the Central London market produces.

An improvement in the economic environment will likely see some rental growth overall in the medium term. However, the much reported rental growth figures we are seeing from some commentators, in particular for Central London, needs to be treated with some caution.

We are now starting to see an increase in active requirements as businesses look to expand in London. Much of this requirement is being driven by the TMT sector (22% of total take up in central London over 2012) as was evidenced by Google’s move to Kings Cross.

Technology continues to create employment and act as the current major business sector contributor to transactional activity both in the West End and the City. Technology companies are embracing new areas and we are seeing evidence that the building itself is often more important than the geographical location.

For further information please contact:

Sarah White Head of Marketing Tel: +44 (0)20 7297 4480 Email: [email protected]

London Market Outlook€¦ · London Market Outlook February 2013 5 London – The Global City Drivers of Investment into the Capital London, along with New York, is the leading financial

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