The 6 Records That Sum Up U.K. Property’s Tumultuous Year
Numerous U.K. real estate records have been broken in 2017: for capital values, investment volumes for certain sectors, and activity in the market from players like local authorities.
To mark the record-breakers-themed fundraising day for property industry charity LandAid, and with help from CBRE and building consultancy Paragon, Bisnow examined some of the records being set and what they really mean for the U.K. real estate sector.
1. Walkie Talkie and Cheesegrater sales
The sale of the Cheesegrater to CC Land for £1.15B in March set a record for the highest capital value per square foot for a U.K. office building, at £1,885/SF. Then the sale of the Walkie Talkie to Lee Kum Kee took the crown as the largest-ever U.K. office sale at £1.3B.
In spite of the uncertainty caused by Brexit and the general election, prime London offices are breaking plenty of records. But there is a lot of nuance behind the numbers.
“What this shows is how the prime London office market is being propped up by Chinese and Hong Kong-based investors, in particular,” CBRE Global Investors head of U.K. research Andrew Angeli said. “The market feels fragile, if it wasn’t for this capital then that market would be in a very different place.”
This fact is highlighted by another record — there were just eight office deals in London undertaken by U.K. institutional investors in the first half of 2017, a record low.
The driver behind this is the record currency volatility of the pound which, while not quite at record lows against the dollar, are close, which is making U.K. real estate seem cheap to investors like those from Asia who typically hold assets in dollars.
2. Record-low interest rates
Interest rates in the U.K. have been at a record low for more than eight years now, which has helped boost real estate prices to record highs in almost all markets.
But Bank of England Governor Mark Carney has indicated that, with inflation rising, rates will likely rise modestly in the near future. The big question for real estate is how capital flows will alter when rates rise — will the sector retain its attraction?
“We continue to believe that unforeseen increases to borrowing costs present one of the greatest threats to an indebted consumer-driven economy,” Angeli said.
3. Record low yields for South East industrial assets
We have seen that U.K. institutional investors have not been buying London offices, so what have they been buying? The answer is South East industrial assets, which have seen prices rise by almost 10% in the past year, Angeli said. This has driven yields in the sector to below 5% — levels that have been historically associated with retail assets. Savills reports that £2.3B was invested in industrial in the U.K. in the first half of the year, 150% above the long-term average.
“Industrials in the South East have really driven the performance of the market this year,” he said. “Our business has certainly benefitted from that but we are becoming increasingly worried about exuberance in the sector. Many assets are now priced to perfection. You could argue that there has been a paradigm shift in terms of how performance is generated, we’re now buying industrials for growth as the sector is benefitting from strong structural forces and dwindling supply, but pricing has undeniably moved in a very big way.”
4. Huge demand for long lease index-linked assets
The other area domestic institutions have been buying into is assets with long, index-linked leases.
“Our investors have almost limitless demand for that kind of product,” Angeli said, and again yields for these assets remain rooted to record lows. Unlike traditional commercial leases, Angeli said he is “less worried about pricing, as long as the income is incredibly secure”.
5. Mayfair’s £100/SF rent glut
This year has seen a record number of leases signed at £100/SF: 36. But this headline figure masks a more nuanced underlying picture. Rent-free periods are becoming longer to maintain the headline rent, with 24 months common. CBRE said top rents have fallen from £120/SF to £105/SF, and could keep falling.
“From a supply perspective, the West End including St. James’s is seeing ample supply being delivered this year and next," Angeli said. “So it’s better to let up on generous rent frees than sit on empty stock and try and let up when market rents will surely be lower.”
6. Councils become big players
U.K. local authorities have made a significant and high-profile entry into the property market in the last 12 months, providing competition to traditional investors for assets both within and beyond their jurisdictional borders. They accounted for 5% of the investment market in the first half of the year, a record figure, against a historic level of 1% to 2%.
Just like traditional investors, they have been arbitraging the spread between the yield at which they can borrow money and the yield on the assets they are buying, and they have been using the income from properties to plug gaps left by government cuts.
But there have been worries that as nontraditional investors, they have been buying assets that they do not necessarily have the skills to manage, and the U.K. Treasury has initiated moves to stop them investing beyond their boundaries.
“The resilience that the U.K. property market has enjoyed over the past year will not be sustained indefinitely,” Angeli said. “We feel that now is an opportune time to be disposing of assets that we don’t want to hold during the next downturn.”