THE conference room at the Berkeley Hotel in Knightsbridge was bursting at the seams as lot 14 was announced — the freehold of a practical but unlovely three-storey brick building just off the High Road in Wood Green, north London.
“Bit of potential, bit of planning, near to the Underground station. An interesting, interesting block,” waxed Duncan Moir, the affable auctioneer from Allsop, to 250 would-be purchasers sitting and standing in every scrap of space in the room.
This packed audience was testament to the craze among private investors for owning shops and offices, and to a wider boom in British commercial property. After returns of 18% and 19% in the past two years — well above the normal 7%-8% — the question many old hands in property are asking is whether this is a bubble, or merely a hectic phase in a long upswing.
Moir asked for an opening bid of £1.75m, and immediately hands went up all over the place. Bidders were attracted by the £132,000 rent that comes in each year from the occupants — a children’s clothes warehouse, a convenience store, a kebab shop, a phone-unlocking service and six flats leased to the council.
“£2m I’m bid. That’s good, bold bidding,” said Moir, as a decisive young man in the front row quickly upped the ante.
“Don’t let him frighten you,” the auctioneer advised a second bidder, wearing a white shirt and standing at the back.
The two men were soon locked in a battle, as the bidding rose above £2.2m. Eventually “white shirt” went up to £2.27m, forcing his rival to concede. “I’ve got to miss it, mate,” he told Moir, shaking his head forlornly and gathering up his belongings.
Commercial-property auctions aimed at the general public are held several times a month in London, and draw at least twice the number of people they did a decade ago when prices were low.
Alastair Hughes, European chief executive at the property and investment firm Jones Lang Lasalle, said: “When I graduated in the early 1990s, I used to be sent down to the auction room to sit there and make it seem busier.”
Today’s would-be buyers are not City types. George Walker, partner at Allsop, said: “I’d say 30% would be full-time property people, the rest small-business men, shopkeepers, pharmacists, lawyers and hoteliers. Three-quarters of them are gearing up with debt in the hope of making capital gains.”
In 1996 the total proceeds from Allsop’s commercial auctions during the year were £227m. By 2001 this had risen to £597m, and in 2005 it hit £1 billion.
At the auction I attended, buyers snapped up 147 freehold properties, including 19 Barclays branches — part of a batch of 700 the bank is selling off — and 12 branches of Threshers, the off-licence.
There are plenty of other signs of exuberance in property. Richard Jones, head of life funds at Morley Fund Management, a property manager, said his firm had been sinking about £400m a month into commercial property to meet investor demand for its Norwich Property Unit Trust and property-linked bonds. The former has net assets of £2 billion, double the figure of two years ago, and is mostly owned by private investors.
Corporate players are equally hungry. The annual Mipim European commercial-property conference in Cannes last month drew 21,415 delegates, up from 17,641 in 2005 and 15,157 in 2004.
Joe Valente, head of research at DTZ, the property-advisory firm, said: “At Mipim, I was astounded by the sheer weight of capital still waiting to be invested in real estate.”
In the past two years the property sector of the stock market has appreciated by 160%, outperforming the FTSE 100 index by nearly 100%. The advent of real-estate investment trusts (Reits), spurred on by revised proposals in Gordon Brown’s March 22 budget, may give the sector even more momentum — because big quoted firms such as Land Securities and British Land will have the option of converting themselves into these tax-efficient vehicles.
Figures from DTZ on returns (the average increase in property values plus rental income) show that, since the slump of the early 1990s, commercial property has had 13 good years in a row. Returns have averaged 12.8% over the past decade.
Inevitably, average “yields” — the rental income divided by the capital value — have fallen. Estimates are that rental yields on commercial premises have fallen from 8.5% in 2001 to 6% now, leaving a much reduced margin over short-term interest rates, at 4.5%.
For some types of property, yields have dropped even lower than this — at the Allsop auction, for example, one branch of Barclays, in Stansted, sold to a local investor at a rental yield of just 3.4%, one of the lowest yet at one of these events.
So has commercial property become a bubble, as it was in the late 1980s? Some prominent market observers suspect it has.
Andrew Smithers, head of Smithers & Co, the consultancy firm, said: “In my view, the overvaluation of property is simply part of an overvaluation of all assets, resulting from the massive injection of liquidity by central banks into the world economy after the technology crash of 2000.”
Nick Leslau, one of Britain’s best-known property entrepreneurs, also thinks the market has overheated. He said he turned bearish 12 to 18 months ago, selling most of the properties his companies owned, aside from £1.3 billion worth of pubs, Travelodge hotels and nursing homes.
“The market has continued to steam ahead,” said Leslau, “but my position has not changed: the more that yields compress as wild capital flows seek a home in commercial property, and rent increases do not compensate, the harder the market’s eventual fall may be.”
The Bank of England also believes there is cause for concern. Its Financial Stability Review, published at the end of 2005, noted that there had been “substantial growth in banks’ exposures to the commercial-property sector in the UK and internationally”.
It said that 39% of total UK bank lending to private non- financial companies was now going to the commercial-property sector — compared with 18% in 1998, 22% at the last peak in 1992, and less than 10% in the early 1980s. By the fourth quarter of last year, bank exposure to property companies had reached £405 billion.
However, the bubble theory is challenged by many in the sector. Paul Hodgkinson, chairman of Simons Group, a £250m- a-year construction firm specialising in retail developments, thinks the property market may have another 18 months of strong growth ahead of it.
“There is a wall of money waiting to be invested in property. The cost of borrowing is still low, and there is good demand from retailers for space in the kind of mixed-use town-centre schemes we offer.”
Hughes, at Jones Lang Lasalle, said circumstances were very different from the last boom-bust 15 to 20 years ago, and not just because interest rates are 4.5%, not 15%.
“Look out over London and you will see that there are not many cranes. In 1989, at the peak of the last boom, there were 1.5m square metres of speculative-development completions in London. In 2005, by contrast, there were only 445,000 square metres of speculative completions.”
Many of the market’s tycoons seem undimmed in their confidence. They do not get any wealthier than the Duke of Westminster, whose Grosvenor Estates is powering on with its £900m Paradise Project in Liverpool.
Grosvenor chief executive Stephen Musgrave said the project, unfolding on 42 acres in central Liverpool between now and 2008, will create “a series of streets and squares, some like Oxford Street, others like Burlington Arcade. There will be a mixture of residential, leisure, hotels and retail.
“We have done a great deal of research on retail demand and supply,” said Musgrave. “At present Liverpool has one of the shortest prime shopping streets in Britain, and unsatisfied demand from retailers for quality space.”
The duke is being trumped in terms of project size by Westfield, an Australian firm. It is spearheading the £1.5 billion White City shopping centre scheme in west London, by the M40, due to open in 2008.
Instead of 43 acres of wasteland where exhibition buildings and a railway depot used to stand, motorists on the M40 now see 10 cranes, standing 150ft high, plus umpteen concrete mixers and 1,000 ant-like building workers.
Michael Gutman, managing director for the UK and Europe at Westfield, said: “We believe the UK is fundamentally undersupplied with high-quality retail space. This will be the largest shopping centre in greater London, but also a lot more besides — with cinemas, bars, restaurants, health clubs and gyms.”
Westfield accepts that when it comes to the property market, “things go up and down”, but Gutman said: “We take a long-term view. We hope to be here for a long, long time.”
Britain’s biggest property firms — British Land and Land Securities — reject the bubble theory but do have concerns about valuations in some parts of the market.
Stephen Hester, chief executive of British Land, said: “This is quite different from the late 1980s, and I am not predicting a crash or even a negative move in values.
“Property as a whole has moved from being undervalued to being fair value. However, even though that is the overall position, we believe there are individual properties and classes of property where people are paying over the odds.”
Land Securities has been selling a steady stream of retail properties in recent months, the most recent being four retail parks, in Leeds, Halifax, Fareham in Hampshire, and Gloucester, for £67m.
The company’s chief executive, Francis Salway, said: “There are two issues to look at. First, is the market in a bubble in terms of rents? Absolutely not. Office rents in London and most other places are at or below previous levels, whereas in the late 1980s there was real rental growth of 15% to 20%.
“On that side, things do not look overheated. For example, we believe we will get good returns from developing central London office properties.
“Second is the issue of yields and the pricing of property investments. Property yields moved in line with the cost of borrowing until December 2005, but the two have moved in different directions since then. Some 50% to 60% of the cost of property purchases in Britain is being funded by debt, and the maths on these transactions has got tighter.”
Land Securities’ biggest project will not boost capacity until 2009, assuming it gets the go-ahead. Its plan to build a 45-storey (630ft) office block at 20 Fenchurch Street in the City — taller than the NatWest Tower — would add 850,000 square feet of office space.
In the meantime the biggest test of the market may come in retailing, if consumer spending falters just as new shopping centres open.
Do derivatives make it more risky?
NO bull market would be complete these days without a part being played by derivatives, and the commercial-property boom has its own — commercial mortgage backed securities, or CMBSs.
The Bank of England has observed that these instruments are ‘facilitating additional leverage of exposures’ to property.
That sounds ominous, but CMBS experts argue that the opposite is true: that CMBSs actually allow banks to sell on some of the lending risk on particular property projects to other investors such as pension funds, insurance firms and hedge funds, and therefore the whole system becomes less fragile.
Hans Vrensen, director of securitisaton research at Barclays Capital, said: ‘CMBS results in a more widely held lending exposure to commercial property compared with the traditional bilateral lending — this should reduce overall market risk.
‘If there was a deterioration in the commercial property market, the impact would be shared by many different parties,’ said Vrensen.
European issuance of CMBSs reached €41 billion (£28 billion) in 2005, twice the amount in the previous year and up from virtually nothing in 1998.
Vrensen predicts 50% growth in the CMBS market this year.
