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OPINION

Property Matters: Life in the old dog yet

Property Matters: Life in the old dog yet
September 11, 2014
Property Matters: Life in the old dog yet

But is it a case of London becoming frothy while the rest of the country is still playing catch-up? Let's take a recent property transaction to gauge the temperature of the London market.

Recently the Crown Estate and Norges Bank acquired a 64 per cent stake in the Pollen Estate of 43 buildings in Mayfair and Soho for £381m from the Church Commissioners. So far, so good. But looking a little closer reveals that there were 86 prospective investors. These included a wealth of interested parties still keen to take a stake in what they obviously believe is a good place to park funds. Aspirants included banks, pension funds, charitable foundations, institutions, sovereign wealth funds and real estate investment trusts (Reits). The bottom line is that the sale was effected at a 50 per cent premium to the initial asking price of £250m.

Put this into real estate speak reveals an initial yield of 2.5 per cent. That's pretty tight when considering that retail landlord Shaftsbury's portfolio of West End properties was last valued at 3.7 per cent on an initial yield, while CapCo's Covent Garden portfolio was valued at 3 per cent.

It's also worth pointing out that the yield on the latest transaction has been depressed to some extent by the reversionary nature of the portfolio. Specifically, around 60 per cent of the portfolio is let on long leases that only revert back to freeholder between 2039 and 2257. To put it another way, the transaction equates to a capital value of around £775 per sq ft, a long way below the current £1,000-£1,500 currently paid for commercial space. The bottom line is that new investors are executing a headlong rush into a market that has some way to go in terms of appreciation. Or, adopting a more sensible longer-term view (and given the length of the lease maturities), this portfolio represents an asset that will deliver rental income and capital appreciation beyond the next cyclical peak.

The goal posts on this peak has been steadily moved forward, based on the assumption that supply will have to be enhanced significantly in order to meet demand. Office space in London is in short supply. So, even though the take up in office space in the seven months to the end of July was up 17 per cent from a year earlier, availability has decreased every month, and at the end of July was down 21 per cent from a year earlier. Availability across central London is now running at nearly a third below the 10-year average. Small wonder, then, that investors are keen to grab a slice of the property market, given that businesses in the capital remain bullish about employment levels, with over half expecting UK economic growth to continue.

One effect of the relentless compression on yields brought about by capital appreciation outstripping rental growth is a steady ripple effect on property values outside central London. This looks set to continue as property appreciation continues to gnaw away at returns. Traditional property companies have already moved de-risking further up the agenda, thus squeezing investments on the development side as emphasis switches to building up rental income on existing assets.

Looking outside central London but inside the M25 ring, vacancies for prime office space are now back down to where they were before the credit crunch, and the supply pipeline remains limited. If growth in rental value of 4-5 per cent is maintained for another two years, this would take rents back to the highs touched in 2008. The difference this time around is that occupier demand is rising more rapidly that it did then, while supply of new space is that much tighter than it was six years ago.

One of two things has to happen to knock the trend. The first is a significant increase in supply; in the best of worlds this will take years to achieve. Or there has to be a notable decline in demand. This implies a slow down in economic growth, which, although inevitable at some point, doesn't seem likely just yet.