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Property Market Report January 2006
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Property Market Report | City of London |
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City of London Commentary January 2006 Contents
My predecessors used to measure the financial state of the City by the number of Porsches on the streets and I am sure they have increased over the past couple of years. However, perhaps we should be looking elsewhere for the signs. The early part of the year saw a competition at the Royal Exchange with the prize of a £60,000 solid silver vodka bottle holder encrusted with diamonds, the entry fee being the purchase price of a cocktail. It appears that the City will be getting taller over the next few years as there are four schemes proposed at over 200 metres. These are Bishopsgate Tower at 288m, St Botolphs Houndsditch at 247m, the Heron Tower at 242m and 122 Leadenhall Street at 225m with all but the Bishopsgate Tower having planning permission. However, they will all be dwarfed by the proposed ‘Shard of Glass’ at London Bridge which will come in at over 300m. For comparison purposes St Paul’s Cathedral is 100m high. Interestingly, the Civil Airports Authority have a say in the matter of height with a limit of 307m above sea level in Central London to avoid encroachment into protected airspace. All we need now is a further increase in tenant demand and these dreams of a couple of years ago will become reality. The main story this year has been the red hot investment market which has continued apace on the back of strong demand from many investors from across the world and fuelled by the availability of cheap medium and long term debt. This has resulted in yields being driven down to levels unheard of since the early 1980’s when base rates were in double figures, there was actual rental growth and the income was secured on mainly 25 year leases. Yields may look low but with the potential for rental growth for the first time in four years many investors consider them competitive when compared to bond yields. Mainly global investors consider Central London investments as a safe part of a worldwide investment policy with higher yields coming from riskier parts of the world. It is clear that property cannot escape being part of the global economy. There is a concern that many investors are overlooking the fundamentals. There may be potential rental growth but shorter leases mean closer reversions with the attendant problems of voids and holding costs, not forgetting the issue of depreciation. A building in the City may be obsolete within twenty to thirty years and revert to site value. There is a suspicion that many of the investors have overlooked this whilst concentrating on the current income and initial yield. The Bank of England’s warning at the end of 2004 about the risks in lending on commercial property appears to have gone unheeded. The German closed end funds have been big purchasers due to low returns at home with their open ended cousins being amongst the sellers due to investors withdrawing their money and the funds having to buy back shares. In addition, hardly a week goes by without a new property fund being announced, many investing in Central London offices and promising double digit returns! A large number of these are based in Jersey to avoid the payment of Stamp Duty Land Tax at 4%. Investors are and will continue to be attracted from across the world as a result of London being considered one of the worlds great financial centres. Take up this year looks like being very similar to last year being in the region of 400,000 sqm. This has resulted in availability falling by 30% to approximately 600,000 sqm. The fall in availability combined with continuing strong demand is the reason many are hopeful for increases in headline rents in 2006. Rental growth in 2005 has proved elusive although incentives have started to be reduced. The FTSE continued its upwards curve with the FTSE100 reaching a four year high in December and showing an increase of over 15% on the year. The Real Estate Index did slightly better at 18% but only matched the All Shares Index as compared to last year when it far outperformed the general market. Its difficult to predict what will happen next year as companies will be hit by residential property being omitted from SIPPS, but the introduction of REITS may soften the blow. The November 2005 report of the Ingleby Trice Kennard City Floorspace Survey shows a healthy increase in take up of 39,612 sqm representing a 47% increase on what was a very poor October 2004 figure and a 13% rise on the six month average. Take up has been mixed over the year with a low of 21,350 sqm in May and a high of 57,019 sqm immediately afterwards in June. Total take up to November stands at 366,000 sqm. The total availability in the City at the end of November 2005 stood at approximately 625,000 sqm as compared to a 2004 year end of 876,000 sqm ie a fall of 28.5% over the year to November. Hopefully availability levels will continue to fall. The agents are optimistic that 2006 will see the revival continuing in terms of demand but this will depend on interest rates remaining low and healthy growth in the economy. There are supposedly a number of large requirements including Aon seeking upto 27,900 sqm, Benfield with 18,600 sqm and KPMG who have been looking for upto 46,500 sqm for the past couple of years. There are a number of law firms also seeking space in the City.
Rents and Rental Trends Although prime rents have generally remained at £485 sqm to £510 sqm there have been a number of lettings in the ‘Gherkin’ 30 St Mary Axe EC3 of individual floors reportedly at up to £550 sqm and a small letting at 41 Lothbury EC2 at £590 sqm. January saw a letting of five floors on a new 2005 development at Moorhouse 119 London Wall EC2 at £485 sqm. Further lettings in the first quarter included space at 1 Plantation Place EC3 let to QEB International Insurance at £485 sqm, 5,075 sqm at the new development at Times Square, Queen Victoria let to Decherts at £375 sqm reflecting its off peak location and a similar level of rent at Alder Castle, Noble Street EC2. Juxon House St Paul’s Churchyard EC4, a 2003 Standard Life development, saw a letting in May at approximately £485 sqm for 3,850 sqm. Small lettings in quarter two included space at 1 Plantation Place EC3 let at £538 sqm and Capital House King William Street EC4 at £510 sqm. The main letting in quarter three was of further space at 10 Gresham Street EC4 taken by Lloyds at £510 sqm. Further lettings took place at 140 Aldersgate Street EC1 at £375 sqm and UBS took 10,350 sqm at 1-2 Broadgate EC2 at £430 sqm. 20 Cursitor Street EC4 was the subject of a pre let early in quarter four to solicitors Macfarlanes at £385 sqm for 3,102 sqm. Three further floors of 3,900 sqm were let at Plantation Place South EC3 at £460 sqm and close by the 2004 development at 60 Fenchurch Street saw 929 sqm taken at £440 sqm on a ten year lease. The main interest in the last quarter has been the flurry of interest in 30 St Mary Axe referred to above at rents upto £550 sqm. One pre let of interest has taken place in Midtown at New Street Square Fetter Lane EC4 where Deloittes have taken 23,600 sqm from Land Securities. It is rumoured to be on a 20 year lease with upto 4 years rent free at £430sqm to £485 sqm. I would be surprised if it is much over £430 sqm given the location and the age and condition of the surrounding buildings, notwithstanding that the majority of these are due to be redeveloped. City workers have never had it so good with a number of developments opening and others in the pipeline. October saw the completion of the Bishops Square office and retail scheme in E1 just outside the City boundary adjoining Spitalfields Market. Twenty one shops are to open totalling some 4,000 sqm. Tenants already signed up include Patisserie Valerie, Evans Cycles and menswear retailer Oscar Milo. Close by at 250 Bishopsgate five more shops are under offer. Ten retail units were created in the redevlopment of Plantation Place, all now let with Zone A rents of £1,775 sqm. At Cheapside EC2 things are looking up with twelve new office developments planned over the next five years with more than 50,000 sqm of associated retail planned. It seems unlikely that all of this space will be developed but a fair proportion should come onto the market over the next few years which should hopefully revitalize what was ‘the high street of the City’ not that long ago. The largest of these proposals is at One New Change where over 20,500 sqm is planned by Land Securities. However, the scheme likely to open first is at Bow Bells House where work appears to have started to provide 1,630 sqm by 2007. Retailers having requirements in the City supposedly include Tesco, Waitrose, Zara, Monsoon and Next. These are from 465 sqm upwards and will therefore be difficult to accommodate within buildings predominantly developed as offices. However, there are a number of retailers with smaller requirements which might be more easily satisfied. The demand is being fuelled by the increase in the number of City workers and their spending power. The restaurant/pub A3 sector has seen some activity with a letting at 30 St Mary Axe in April at £120,000 pa analyzing to £430 sqm overall which is an exceptional rent reflecting the location. Other similar lettings in City have generally ranged from £240 sqm to £280 sqm overall. The low yields were not restricted to office investments. 143-144 Fleet Street EC4 sold in June at £3.75 million reflecting a yield of 4.4%. The Royal Exchange in the heart of the City with its range of upmarket shops sold at £54 million but the yield was not disclosed. We thought last year was good for the City investment agents but these past twelve months have been even better! Savills estimate sales of £8 billion took place, 23% up on last year when sales of £6.5 billion was a new high. Sales this year are nearly 50% up on the previous peak in 2001. I have referred to the reasons for this in my introduction and simply it is a combination of cheap debt and low returns on alternative investments such as bonds. Even the increased returns on equities does not seem to have dented the demand which now comes from across the world where City property is seen as being low risk in global terms. Many experienced surveyors are now questioning the rationale behind the current level of yields and how long they can be sustained without rental growth. Property is not risk free, there is always the possibility of voids with not only the loss of rent but holding costs such as empty rates etc. In addition, negotiations at rent reviews may be costly and depreciation is always looming which in the City is a short and medium term problem rather than a long term problem as elsewhere in the UK. Supply has increased in response to the falling yields but demand is still in the ascendancy. This has resulted in more money going into secondary investments and opinion is that the yield differential between these properties and prime ones has narrowed. Again one would question the logic given the additional risk inherent in such properties due to the factors which make them secondary ie location, age and strength of covenant. Securitisation is beginning to become a more popular a form of financing as it creates a more easily tradable ‘asset’. Simply a bank lends money to borrowers to buy a property and the bank then issues bonds against the loan which are secured against the income stream. The value of these bonds will depend on their credit rating so if the underlying asset is a prime investment this would attract a higher rating resulting in a higher value and lower initial return. As this is only cost effective at levels over £200 million lenders will generally have to build up a portfolio of smaller loans before going down this route. However, there will be larger transactions which will be able to be securitised on an individual basis. Market commentators consider that this method of financing purchases will grow rapidly over the next few years. There have been at least eight investment sales over the year in excess of £200 million representing 35% of the total turnover of £8 billion. In February the sale of the iconic Lloyds Building at 1 Lime Street EC3 completed at £231 million to Commerzbank AG. April saw the sale of Land Securities 30 Gresham Street at £274 million to the Government of Singapore Corporation at an initial yield of 5.6%. There was a rare sale of a large investment in the Western fringe when Goldman Sachs completed a sale and leaseback of Peterborough Court, 133 Fleet Street to Tishman Speyer at £280 million, no yield has been quoted but in view of its location and early 1990’s age I suspect the yield would be in the 5.75% to 6% range. In the second quarter Canary Wharf Group purchased 200 Aldersgate EC1 for £209 million. The second half of the year saw the Woolgate Exchange, 25 Basinghall Street EC2 sold to Bankhaus Woelbern for £290 million. In November Matrix sold Alban Gate, 125 London Wall EC2 to Buckingham Securities for £312 million to show a 5.75% yield having purchased a 10% share from the Corporation of London in April at £29 million. Doric Asset Finance Ltd acquired 5 Old Broad Street EC2 in November at £200 million to show a 4.5% yield. Doric also acquired a smaller investment at 7 Newgate Street EC4 in September at £63 million at a 5.3% yield. Clients of UBS bought 60 Victoria Embankment EC4 in this period at £265 million reflecting a 6.4% yield. The end of the year saw two sales at yields close to 5% with 12 Moorgate EC2 showing a yield of 4.95% off a sale price of £28.3 million and 1 Fleet Place EC4 also selling for just below 5% to Legal and General for £120 million. If the current market conditions continue then a well located single let building with a good covenant and medium to long term security of income may command a yield of 5% or less. Although many observers are suggesting things cannot continue as they are, conditions seem unlikely to change in the short term given the continuing low interest rates. If these start to drift out then yields may rise but with potential rental growth this is far form certain. Whilst recently gazing over the City from the top of the dome at St Paul’s Cathedral (well worth the £9 entrance fee alone) it was apparent that, although this is not a boom time for development, it is much healthier than last year when the cranes could be counted on the fingers of one hand. Drivers Jonas reported in November that there had been a 41% surge in speculative building in Central London with 90,300 sqm in the City. In addition, there was a further 84,355 sqm which I assume was the subject of pre lets. The levels are still low by historic standards so there is likely to be a rush of developments getting off the drawing board this year. The problem is that given the length of time it takes to obtain planning permission coupled with securing funding and then the construction period it is possible to completely miss an upturn in the market. We may have two or three years of increased tenant demand and rental increases but developments planned now may not be up until after this period ends with disastrous results if demand then drops off. However, developers are used to this as it is not a new phenomenon. This year has seen Greycoats 10,100 sqm Condor House at St Pauls Churchyard EC4 completed and 1-10 Bishops Square Spitalfields E1 just across the border in Tower Hamlets comprising offices for Allen and Overy and twenty one shops. Although development is proceeding apace only a couple of schemes are due for completion in 2006. No. 5 Aldemanbury Square EC2 is a joint development by Scottish Widows and Teachers which already has steelwork up to the 10 th floor and the core to the 18 th but no tenants as yet signed up. 15 Fetter Lane EC4 will provide 7,620 sqm by the summer. Other speculative schemes under construction and likely to complete in 2007/2008 include Land Securities’ One Wood Street EC2 which offers 15,050 sqm. There was a tenant lined up to take the space earlier this year but they went to Canary Wharf instead. St Martins Property are redeveloping 150 Cheapside EC2 to provide 18,600 sqm of offices and 1,580 sqm of retail on a 0.29 Hectare site. British Land are underway on 16,700 sqm of offices at Ludgate West at the bottom of Farringdon Road EC4 and close by Unilever House Blackfriars EC4 is the subject of a redevelopment by Bovis Lend Lease and Stanhope to provide 23,000 sqm by early 2007. 35 Basinghall Street EC2 was the subject of a sale and leaseback in March by Standard Chartered Bank. They will occupy 21,100 sqm and the sale was at £170 million showing a yield of 5.5%. Construction is also underway at 51 Lime Street which was the subject of a prelet in late 2004. An area which has seen a number of proposals in recent times has been Fetter Lane EC4 and these now seem to be coming to fruition. Land Securities have finally resolved their rights of light issue and have commenced their 64,200 sqm development of New Street Square with Deloittes already signed up to part. British Steel Pension Funds 15 Fetter Lane will complete in the summer and has an asking rent of £403 sqm reflecting its Midtown location. Delancey’s Rolls Building will provide 25,080 sqm although the site is very quiet at present. Land values have risen as a result of lower yields and better prospects for tenant demand and rent increases. 1 Tudor Street EC4 sold in July for £9.25 million. The site has consent for 5,202 sqm of offices which represents £1,775 sqm. However, it should be noted that a short term let has been arranged with the contractors at Unilever House EC4 running until early 2007. In a more prime location the freehold of Bank Buildings, 1 Lothbury EC2 was reported to have attracted offers up to £29 million which represents over £3,100 sqm on a proposed floor area of 9,290 sqm. A good number of schemes are likely to come forward especially if the first signs of rental growth materialise since the 2001 peak. Whether any of these schemes will include the proposed skyscrapers is another matter, and probably unlikely unless they are able to obtain significant prelets. Much of what was said last year in this article could be repeated about increases in lettings and rental growth. However there is a much stronger case this year for making this same prediction. The cranes have returned and these will only increase in number over the year as new schemes come forward and little is completed in 2006. There has been no mass exodus to Canary Wharf although Land Securities did lose a potential banking tenant at One Wood Street EC4 to the Docklands. Planning Gain Supplement, to be levied on the uplift in values as a result of planning permission, looms on the horizon and has been extended to include commercial properties. I suspect that the effect in the City will be somewhat less than elsewhere given the brownfield nature of the sites and the likelihood of significant existing use values. However, there is some good news in that REITS will be coming soon after much lobbying by property companies and others in the property industry. |
