London Lots Soar as Cash-Rich Funds Fill Bank Void: Mortgages

Brookfield Office Properties Senior VP Martin Jepson
Martin Jepson, senior vice president for development and investment at Brookfield Office Properties Inc. Source: Brookfield Office Properties Inc. via Bloomberg

Great Portland Estates Plc didn’t have to build a thing to boost the value of its development site in London’s Mayfair district. The 1.3-acre plot appreciated by 10 percent in the second quarter, almost twice the return that income-producing office buildings there will generate this year.

Development in the U.K. capital is gaining appeal as a lack of bank financing for construction contributes to a scarcity of new properties and bolsters land values in areas like the West End, where a concentration of hedge funds has helped lift rents to the second-highest in the world after Hong Kong. The value of Great Portland’s Hanover Square has climbed about 50 percent since April 2011, a month before the real estate investment trust won permission to build there.

U.K. banks are, for the first time in at least 11 years, unwilling to finance development projects without a tenant committed to lease space or a buyer for the completed property, according to a study by De Montfort University. The lack of lending means investors with cash like Qatar’s sovereign wealth fund, private-equity firm Carlyle Group LP and U.K. REITs such as Great Portland can construct buildings that will be in demand when they’re completed.

“The ability of people to play the development game in London is pretty much limited to those with large equity checks, sovereign wealth positions or very strong balance sheets who can bring on board corporate debt,” Martin Jepson, Brookfield Office Properties Inc.’s senior vice president for development and investment, said in an interview. “That’s one of the reasons London is attractive to us.”

Building Plans

About 5 percent of all central London commercial real estate spending in the first half of 2012 was on development sites for offices and shops, from virtually zero last year and

2.6 percent in 2010, according to Martin Davis, U.K. research analyst at broker DTZ.

Development usually carries higher risks and greater potential returns than investments in completed commercial properties with rent-paying tenants in place. A shortage of prime commercial real estate for sale in London is reducing the risk.

Total return, a combination of rent increases and property value gains, will be 5.8 percent in the West End this year, down from 12.4 percent in 2011, according to an estimate by Jones Lang LaSalle Inc. City of London returns will fall to 4.5 percent in 2012 from 13.1 percent last year, the property broker forecast.

Monthly rents for prime offices in the West End averaged

92.50 pounds ($144.74) a square foot last year, broker Knight Frank LLP said in a March report.

Savile Row

Mayfair is popular as an office location for hedge funds, including Moore Capital Management LLC and GLG Partners Inc. Savile Row’s renowned tailors and Claridge’s Hotel are a few streets away from Hanover Square. British Land Co., which will develop the Clarges Estate on the opposite end of Mayfair, may return a profit of more than 20 percent when the project is finished, according to JPMorgan Chase & Co.

Brookfield agreed in June to buy a site at Principal Place near the City of London as part of a 518 million-pound portfolio purchase from Hammerson Plc. Carlyle plans to develop eight buildings as high as 48 floors on a site near the Tate Modern museum in London’s Southbank district. Qatar will build a Harrods-branded hotel and apartments at Chelsea Barracks, which it bought for 959 million pounds in 2008.

Great Portland has gained the most among members of the FTSE350 REIT Index this year, with a 34 percent gain. British Land increased 18 percent.

Loans Vanish

One in three lenders in the U.K. didn’t advance a single commercial property loan last year, Bill Maxted and Trudi Porter said in a survey by De Montfort University published in May. The trend is continuing after lenders reduced the availability of commercial real estate credit in the second quarter of 2012 and had no plans to increase it through September, according to a Bank of England survey in June.

“There’ll be very little competition in terms of new development,” Irvine Sellar, whose Sellar Property Group developed the Shard skyscraper in London along with Qatar Central Bank, said in a July interview. “Take Battersea Power Station, which I think was overrated as a site, but half a dozen companies were chasing it down.”

Malaysian consortium SP Setia Bhd., Sime Darby Bhd. and the Employees Provident Fund will start the 8 billion-pound development of Battersea Power Station next year on the River Thames in southwest London.

Sovereign Wealth

Sovereign wealth funds have six billion pounds to invest in London, 9 percent more than in November, CBRE Group Inc. said in May. Private buyers had 5 billion pounds and U.S. funds like Blackstone Group LP had 4 billion pounds, the property broker said.

That demand makes owners more reluctant to sell as they wait for prices to increase further, Osmaan Malik, an analyst at JPMorgan Chase & Co., said in a July 25 note.

“There’s a lack of supply, so if you want to invest more money you might have to go up the risk curve a little bit and one way of doing that is moving to development,” Robert Stassen, a research director at Jones Lang, said on a July 19 call with reporters.

Investors from outside of the U.K. have bought two-thirds of the 1.6 billion pounds of development land for commercial real estate by value sold in central London since the start of 2006, according to DTZ data.

Construction Slows

Developing allows investors to take advantage of a slowdown in construction, the biggest drag on the U.K.’s economy in the second quarter, to get buildings completed for less. The cost of erecting an office block with ground floor shops in London’s West End has fallen as much as 25 percent since 2008, Iain Parker, head of European offices at real-estate adviser Davis Langdon, said in an e-mail.

Buying land in London “is probably slightly less risky because you’ve got more options in how you can ultimately develop it,” said Paul Cheshire, professor of economic geography at London School of Economics. “If you buy a high-end residential building in a conservation area or listed building, you’re extremely restricted in what you can do.”

Development has generated a mixed bag of results for companies that started construction on five towers near the Bank of England beginning in 2008. Office rents in the City of London financial district in the three months through March were still 25 percent below their level in the quarter through March 2008, according to Investment Property Databank. Rents have stayed at about 55 pounds a square foot since the last three months of 2010, according to CBRE Group.

Walkie Talkie

Construction on the Pinnacle, a 1 million square-foot (93,000 square-meter) office tower, has stalled, according to broker Drivers Jonas Deloitte. The Heron Tower and the Shard have been completed and aren’t fully occupied. Lease agreements have been signed for part of the space at British Land’s Cheesegrater skyscraper and the Walkie Talkie at 20 Fenchurch Street, a joint venture between Land Securities Group Plc and Canary Wharf Group Plc, prior to the towers’ completion.

Qatar, which owns 95 percent of the Shard, will redevelop most of the Royal Dutch Shell Plc complex near Waterloo railroad station in a venture with Canary Wharf Group.

“This is a long-term investment,” Qatar Central Bank Governor Sheikh Abdullah Bin Saoud Al Thani said of the Shard at a briefing in July. “This is part of our relationship and our confidence about the London market.”

Qatar has invested more than 20 billion pounds in London since the economic crisis, Prime Minister Sheikh Hamad Bin Jasim Bin Jabr al-Thani said at the opening ceremony for the Shard. “There are a lot of things in the pipeline,” he said.

Brookfield Develops

New York-based Brookfield agreed in July to develop an office building on London Wall Place in the City of London with Oxford Properties Group Inc.

Brookfield will fund the purchase of Hammerson’s London buildings by taking on 66 million pounds of debt. It plans to add further borrowings against the property before the deal closes and will also use its own cash, the company said in a June 19 statement. Development of the 1.1 million square feet of office space planned for the two sites will cost about 300 million pounds to 350 million pounds including Oxford Properties’ share, Jepson said.

‘Big Bet’

Brookfield also owns half of 100 Bishopsgate, an office tower planned near Liverpool Street rail station. The purchases are “a big bet on the City of London marketplace but we’re pretty confident long term,” Jepson said. “We’ve got three very good buildings that appeal to different tenants.”

The firm rose 0.2 percent to $16.87 at 10:08 a.m. in New York, extending its gain for the year to 7.9 percent.

Developers should ensure they can attract a diverse mix of occupiers, said Colin Lizieri, a real estate professor at Cambridge University. He cautions against specializing in erecting office buildings for financial services companies in global banking centers.

“If you get a shock in global financial markets, it’s going to affect all of those cities,” he said. “If the idea of having a global real estate portfolio is to protect you from risks and to give you diversification, it doesn’t seem a very obvious strategy to buy in a whole series of cities linked to the same economic drivers.”

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