Buying shares in Real estate investment trusts (Reits) with City development exposure is one way of playing this trend. But a more potent (and perhaps more profitable) route would be betting on the City's "escape valve", namely the Canary Wharf office market.
Previous space shortages in the City have proved beneficial for London's Docklands, which has now established itself as a fearsome competitor as opposed to a second-best location. Boasting some of the largest and best-designed office buildings in London, the district now has everything occupiers need: excellent public transport links, and state-of-the-art retail malls and restaurants.
Its future development rests principally with one company - The Canary Wharf Group. This is 69 per cent owned by Songbird, whose shares are traded on London's Alternative Investment Market.
Crisis was averted last autumn, when the highly geared vehicle's £880m debts were purchased and restructured by a including state-owned China Investment Corporation (CIC) and Qatar Holdings. This has placed Canary Wharf Group back on a sound financial footing, and there are several compelling reasons why investors should not be scared of ruffling Songbird’s feathers:
1). Those in the market believe the Canary Wharf Group could emerge as the principal conduit for future Chinese property investment into the UK. CIC’s multi-million pound investment is not just based on the solid fundamentals of Canary's £5bn investment portfolio (which boasts 96 per cent occupancy and average lease lengths of nearly 15 years). It has bought into the group's substantial development expertise - led by chief executive George Iacobescu - and could yet prove a powerful funding partner for new schemes at a time when most banks are closed for development finance business.
2). In the Docklands market, Canary is sitting on a 5.5m square feet development pipeline and could clean up in a space shortage, as the market returns to pre-letting deals. Shell is reputedly close to signing a 200,000 square feet deal at 40 Bank Street. Separately, if investment bank JP Morgan proceeds with its plan to develop a giant headquarters, Riverside South, this alone will generate a development profit of £148m (or 15.6p-a-share). If it doesn’t, Canary has the option to buy back the site for a song. The success of this deal, combined with substantial pre-letting activity leads JP Morgan’s real estate analyst Harm Meijer to forecast a "bull case scenario" valuation of 266p-a-share (that's 60 per cent upside to today’s price of 166p).
3). Future development potential stretches beyond the boundaries of London’s E14 postcode. Canary has recently completed its first office development in the City, Drapers Gardens. A joint venture in which it controls 20 per cent, management were shrewd enough to spend £113m of autumn’s equity injection on buying the debt secured on the scheme. The entire building has subsequently been leased to BlackRock, and the imminent investment sale could net £240m - some nest egg. So, where else might Canary fly home to roost? The group has already been linked with several sites in the City, and those close to the company believe large-scale mixed-use regeneration projects in London will follow. Not including in the figures above is the giant Wood Wharf JV in Docklands with British Waterways and Ballymore (the 17-acre site will take 15 years to fully develop).
4). The refinancing has prevented Songbird from being knocked off its perch, but gearing is still very high (net debts were shown to be 296 per cent of equity at full year results this month). In a recovering market, gearing magnifies returns – JP Morgan estimates capital growth of 4 per cent on its investment portfolio would cause a 12 per cent jump in net asset values (NAV). As things stand, Songbird's shares trade at a 13 per cent discount to forecast 2010 NAV.
True, there are short term challenges (a potential legal dispute over space vacated by Lehman Brothers, a complicated company structure and the ever-present risk that occupier markets could falter in a double-dip). But Songbird's potential to soar means I recommend taking a flutter on its shares at 166p.
