Hedge Funds Get Squeezed in Mayfair as Offices Become Homes

Landlords Win as Hedge Funds Scrap With Billionaires in Mayfair
Residential properties are seen in a street in Mayfair. Photographer: Jason Alden/Bloomberg

Landlords in Mayfair and St. James’s, two of London’s most expensive neighborhoods, are exploiting a shrinking supply of new or refurbished office space to charge hedge funds and financial firms the highest rents in three years.

Offices are being converted into residences costing 2,000 pounds ($3,100) a square foot or more as demand surges from foreign buyers seeking luxury homes in central London. A shortage of financing for new development and restrictions on high-rise projects add to the squeeze on commercial space.

London, Europe’s main center for hedge funds and private equity managers, has attracted tenants willing to pay high rates for prestigious offices from which to court customers of the private banks based nearby. Owners face the choice of keeping buildings, many of them former houses, as offices or cashing in on a bidding war that has driven up luxury-home prices in the capital by 37 percent in the past five years, according to Knight Frank LLP.

“It’s a wonderful problem to have,” said Andrew Lax, co-founder of Lancer Property Asset Management, which oversees Mayfair’s Berkeley Square Estate, a collection of low-rise buildings on and near the historic square. “Holding the line becomes increasingly difficult.”

The few developers and landlords that raised money to build and renovate office space in the area, such as Grosvenor Group Ltd., stand to benefit the most as increasing rents boost income and lift property values.

Low Vacancies

Prime office vacancies in Mayfair and its southern neighbor, St. James’s, are the lowest in almost three years at 3.4 percent. Net effective rents, which include incentives such as rent-free periods, rose to 82.33 pounds a square foot for Grade A space, broker Jones Lang LaSalle Inc. estimates. That’s the highest since the first quarter of 2009. Sapinda UK Ltd. agreed to lease the top floor of 23 Savile Row for 99 pounds a foot annually.

Mayfair and St. James’s were transformed to office districts after World War II, when bombing destroyed much of the City of London financial center. The areas were the world’s second-most expensive office market for Grade A space last year and held first place the year before, according to a ranking of central business districts compiled by Knight Frank. Hong Kong was the most expensive in 2011. Manhattan was 16th.

Rent Rebound

Rents for the best offices in the London neighborhoods peaked at 107 pounds a foot in the first half of 2008. That sank to 60 pounds in the two years through June 2010 as the credit crisis made firms reluctant to spend on space. Since then, net effective rents have rallied by 37 percent, Jones Lang data show. Egerton Capital LP and Axa Private Equity signed leases in the past 12 months for more than 100 pounds a square foot.

Offices are fetching higher rents even as hedge funds worldwide struggle amid concerns that Greece may exit the euro and the global economy is weakening. Hedge funds fell 2.9 percent in May, the worst month since September, led by long-short equity, multistrategy and global macro funds, according to data compiled by Bloomberg.

Few property companies are able to capitalize on the rising rents by building or upgrading office buildings in the two neighborhoods. Developers are struggling to finance projects as banks cut back U.K. real-estate lending to strengthen balance sheets in compliance with new regulations on capital.

None of 63 the U.K. lenders in a De Montfort University survey released earlier this month planned to finance new property projects without commitments in advance from tenants or buyers.

Foreign Money

As lucrative as the office rents are, the payoff from selling a property is rising as foreign money pours into luxury homes in the capital. Buyers from abroad accounted for about 60 percent of home purchases in the most expensive districts in the four years through 2011, according to London-based Development Securities Plc. Values have climbed by more than 40 percent since March 2009, the low point for the city’s prime residential market after the credit crisis.

Conversions of offices into homes removed about 550,000 square feet (51,000 square meters), or 3.5 percent of Mayfair and St. James’s office stock, in the decade through 2010, H2SO Property Consultants estimates.

A 1730s house on Upper Grosvenor Street used as offices was sold for 18 million pounds earlier this year, exceeding the asking price by 22 percent, because of its potential as a residential development project, said Peter Wetherell, owner of specialist Mayfair broker Wetherell & Co.

Less Attractive

As a rental office investment, the building would have fetched less than 10 million pounds because staircases, kitchens and bathrooms don’t generate an income and so aren’t included in its investment value, he said.

Mayfair’s revival as a place to shop and go out has powered a fivefold increase since 2000 in the average cost of a home on Grosvenor Square, the most prestigious address, to 3,271 pounds a square foot, according to researcher Lonres.com.

“I see Mayfair as a growing market because it has so much potential,” Joe Burns, co-founder of developer Oliver Burns, said in an interview.

Burns sold the penthouse at The Walpole in St. James’s for a district record of 4,542 pounds a square foot. Three 3,800 square-foot apartments are on sale for 11.5 million pounds each. The former office building consists of two heritage-protected townhouses converted into apartments that span both properties.

Navy Property

More Mayfair and St. James’s offices may be lost to projects such as entrepreneur Richard Caring’s planned conversion of the former U.S. Naval headquarters on Grosvenor Square into 37 luxury apartments.

West End of London Property Unit Trust said today that it acquired Buchanan House on St. James’s Square for 66.4 million pounds. The fund didn’t say whether it will keep the property as offices or convert it into luxury residences.

Rio Tinto Plc demolished its former headquarters on the same square and is working with Exemplar, a developer, to convert the site into a mix of luxury apartments and offices. Green Property Ltd. is converting an adjacent historic townhouse used as offices back into a home, while it’s demolished the neighboring property to build new offices that are due to be completed next year.

Record Rent

Permal Group, the fund of hedge-funds unit of Legg Mason Inc., agreed in September 2007 to pay a record 140 pounds a square foot to lease the top floor of an office on St. James’s Square.

The squeeze on office supply benefits the landowners and developers that proceeded with office projects when others delayed projects in the financial crisis and now face little competition.

“We should be sitting pretty,” Peter Vernon, Grosvenor’s chief executive officer for the U.K. and Ireland, said about leasing 50 Grosvenor Hill, a new office on a back street off Berkeley Square and Bond Street.

Grosvenor runs 100 acres (40 hectares) of Mayfair on behalf of its owner, the Duke of Westminster’s family trusts. Its newest office there includes 20,000 square feet of new space behind a preserved Georgian facade that it plans to lease for more than 90 pounds a square foot.

Diminishing Development

Six other office projects, including another one belonging to Grosvenor, are under construction in Mayfair and St. James’s. Owners and developers including the Crown Estate, Land Securities Group Plc and Exemplar are building 559,000 square feet of offices. Just 130,000 square feet of space may be completed in 2014, H2SO estimates.

“There’s a supply shortage because of the lack of development starts and as super-prime residences take the place of offices,” said Paul Smith, co-founder of H2SO. He said Grade A office rents may soon surpass 100 pounds a square foot on a regular basis.

Great Portland Estates Plc said its best-performing asset in the year through March was 1.3 acres of holdings in Hanover Square. The real estate appreciated by 37 percent after the company won planning consent to build shops, offices and apartments on a site incorporating a station for the Crossrail subway rail link under construction. The developer won’t break ground until the end of 2015.

“This is a very rare product in London, given the super-prime nature of offices, retail and residential and the embedded shortage of this type of accommodation in Mayfair over the next few years,” said Neil Thompson, Great Portland’s portfolio director.

Costly Niche

The competition with residential use is accelerating Mayfair and St. James’s transformation into a niche, high-end office market. Westminster City Council said it’s happy with the way it’s changing.

“It has an eclectic mix of businesses that aren’t going to disappear,” said Jonathan Glanz, the councilor who represents the ward that incorporates Mayfair and is Westminster’s cabinet member for housing and corporate property.

For the cost-conscious or those with large space requirements, the alternatives lie elsewhere in London, such as north of Oxford Street, Victoria, Knightsbridge or in landmark buildings including the Shard in Southwark or the Heron Tower in the City of London, said Smith at H2SO.

“There won’t be any more large organizations able to justify being in high-rent space,” he said.

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