Asia Funds Buy London Offices in Bet Volatility Is Past

Asia Bets $5.6 Billion on London Property Market
Malaysian fund Permodalan Nasional Bhd., acquired the European Bank for Reconstruction & Development’s head office next to Liverpool Street train station for an undisclosed price in May. Photographer: Simon Dawson/Bloomberg

Asian investors are the biggest buyers of office property in the City of London this year, wagering that the financial district’s volatile market has changed since it routed Japanese buyers in the 1990s.

Malaysia’s state pension fund and the Korean Teachers’ Credit Union are among investors from the region that spent about 1.77 billion pounds ($2.8 billion) on income-producing office buildings in the district in 2012, more than a quarter of the total, data compiled by Jones Lang LaSalle Inc. shows.

National funds from Asia are increasing their proportion of investments in real estate and looking overseas for higher yields amid slower growth in the region. A weak pound, a reputation as a safe haven and returns that beat financing costs help make London the world’s most attractive city for foreign property investment.

“London for us is purely diversification, flight to safety and a way to get a bit of yield,” said Goodwin Gaw, managing principal at Hong Kong-based Gaw Capital Partners and its Downtown Properties Inc. affiliate. “It’s definitely more of an income stability play because if it was capital appreciation, I would be in Asia.”

Much of the Asian investment, 3.5 billion pounds from 2010, has gone into the City of London borough also known as the Square Mile. Buyers from the Asia-Pacific region surpassed the British in the year through September with 28 percent of the purchases, Chicago-based Jones Lang estimates. That’s up from 24 percent last year and 4 percent the year before.

Growing Rents

The investors have been rewarded, said Alan Carter, a London-based real estate analyst at Investec Ltd. “If you’re getting a 5.5 percent yield and rents are growing, that’s not too shabby at the moment.” Canary Wharf has replaced the City as London’s most volatile property market, he said.

British buyers dropped to 20 percent of the market in the first nine months of 2012 from 37 percent in 2011 as companies focused on development. U.S. investors, the biggest group in 2010, made 19 percent of the purchases by value this year according to Jones Lang. The increase from 7 percent a year earlier was led by Brookfield Office Properties Inc.’s purchase of a 518-million pound portfolio from Hammerson Plc.

The City has changed as a property market since falling values prompted Japanese owners to cut their holdings in the district to 2 percent in 2005 from 11 percent a decade earlier. Development is slower than demand, prices are 25 percent below their 2007 level and strengthening Asian currencies are making London properties more affordable.

Currency Advantage

The Singapore dollar appreciated by about 52 percent against the British pound over the past five years. That means an investor from the country can buy a building in the City for half its 2007 cost, compared with the 23 percent fall for a U.K. buyer, according to broker Knight Frank LLP. The Malaysian ringgit rose 41 percent.

Values in the City of London have lagged behind Hong Kong, where office prices doubled in the three years through September, broker Colliers said in a Nov. 9 report. Office buildings in the Square Mile have risen 35 percent over that time, according to data compiled by Investment Property Databank.

London’s advantage comes from the rent buildings can generate. Gaw said his funds can borrow in the U.K. at a rate of about 4 percent and a City of London investment will give them a cap rate, the property’s net operating income divided by the sales price, of 6 percent to 7 percent or more.

Volatile History

“The income coming off the property generates a significant spread over the cost of funds,” he said in a telephone interview. “It’s something we don’t see in New York and we definitely don’t see in Hong Kong.”

Another attraction for overseas buyers is that they don’t get taxed on the sale of U.K. real estate if they are non-residents, according to Andy Smith, a partner at PricewaterhouseCoopers LLP.

The City’s attractiveness today should be weighed against its boom-and-bust history and values that have fallen by half after inflation since 1980, said Colin Lizieri, a real estate professor at the University of Cambridge.

“City offices have performed appallingly,” said Lizieri, who wrote a study last year that showed overseas buyers own most of the offices in the district. Achieving good returns “is really about knowing when to get in and to get out of the market. Many investors have got that wrong.”

Building Oversupply

Banks tend to increase their property-development investment at the peak of economic cycles, when demand is high, said Peter Rees, the City of London planning officer. As new buildings are completed, supply quickly outstrips demand and continues to rise, he said.

For Japanese buyers in the late 1980s and early 1990s, a record level of development coincided with a sharp drop in demand as the U.K. fell into recession in 1990, said Peter Damesick, chief economist for Europe, the Middle East and Africa at broker CBRE Group Inc.

“They bought shedloads of it in 1988 and 1989 and they paid some very, very fancy prices,” said Investec’s Carter. The Japanese started to “cut their losses” after values began rebounding in 1993 and 1994, he said.

City office values have fallen 26 percent since September 2007, compared with a 15 percent decline in the West End and Midtown, according to IPD. Capital values in the City increased by about 25 percent in the five years through the third quarter of 2007, it said.

Prices Slow

Values in the district may have peaked, IPD said in July. Income-producing City of London office buildings rose 1.3 percent through September, according to its data.

New buyers, including those from Asia, could end the City’s boom-and-bust cycle, according to Rees of the City’s planning department.

“It’s less likely to be producing speculative product and it’s more likely that the investment is long term, which is much healthier for the London market,” he said in an interview.

Gaw’s Downtown Properties bought Vintners Place, an office building partly leased to Jefferies Group Inc., for an undisclosed price in September. The Los Angeles-based company made the purchase in a partnership including the Korean Teachers’ Credit Union and the Korean Federation of Community Credit Co-Operatives.

South Korea

South Korean investors are turning to overseas markets and investments like property because it’s hard to get high returns at home, said Song Hong Sun, head of research at Seoul-based Korea Capital Market Institute’s fund and pension division.

“As aging becomes the biggest concern in the Korean society, these pension funds and credit cooperatives need to aim for whatever extra return from investments they can get,” he said. “And they tend to look at longer-term investment.”

The Japanese are back as well, with Tokyo-based Mitsubishi Estate Co., that nation’s biggest developer by market value, purchasing a Bishopsgate tower occupied by Deutsche Bank AG in June 2011, Cushman & Wakefield Inc. said. A separate plan to develop a new 23,000 square-meter (240,000 square-foot) office block on a site on Finsbury Circus through its Paternoster Associates unit was approved by City of London council members yesterday.

“We have learned that the City market is one of the most fascinating markets to work in because it is one of the most globally attractive for investors and because of its transparency,” Hiroyuki Arimura, Mitsubishi Estate’s U.K. managing director, said in an e-mail. “Currency fluctuations can create additional attractions.”

Mitsui Fudosan

Mitsui Fudosan Co., Japan’s largest developer by sales, bought a site last year at 70 Mark Place in a joint venture with London-based Stanhope Plc, according to a website for the project. Nobody was immediately available to comment on the company’s London investment strategy, according to spokeswoman Christina Lawton.

Japanese billionaire Akira Mori plans to buy as much as 760 million pounds of properties in London, New York and Tokyo, as local real estate values recover and the yen strengthens, he said today in an interview.

Chinese Estates Holdings Ltd., controlled by Hong Kong billionaire Joseph Lau, bought River Court, part of Goldman Sachs existing European headquarters, from a group of Irish investors for about 280 million pounds last year.

A Malaysian group composed of SP Setia Bhd., Sime Darby Bhd. and the Employees Provident Fund will start work next year on the 8 billion-pound Battersea project, about 3.5 miles (5.6 kilometers) from the City of London.

Safest Place

“London is the safest place on earth,” Sime Darby Bhd. Chief Executive Officer Mohd Bakke Salleh said in an interview in September after he and other Malaysian investors acquired the Battersea site. He cited the U.K.’s legal system and transparent market as being the springboard for his company’s plans to expand outside Malaysia.

Malaysian fund Permodalan Nasional Bhd. bought the London headquarters of law firm Linklaters LLP in the City earlier this year. It acquired the European Bank for Reconstruction & Development’s head office next to Liverpool Street train station for an undisclosed price in May. PNB spokesman Nur Akmal binti Ahmad declined to comment on its London investment strategy.

China Investment Corp. purchased Winchester House, leased to Deutsche Bank AG, from KanAm Grund KAG earlier this month for about 245 million pounds, as part of a joint venture with Invesco, CoStar reported.

A Downtown Properties fund will probably invest an additional $300 million to $400 million in the next six to nine months either in London or large U.S. cities, Gaw said.

Development Advantage

Prime properties in development may perform much better than the rest of the market as a slowdown in construction pushes down costs and reduces supply on the market. Land Securities Group Plc’s projects in the U.K. capital have gained 13.4 percent in the six months through September, Chief Executive Officer Rob Noel said by telephone. Its buildings under construction include the Walkie Talkie skyscraper in a joint venture with Canary Wharf Group Plc.

The amount of office space due for completion next year and not yet leased is 1.1 million square feet, according to a Drivers Jonas Deloitte report in May. That’s about 60 percent of the average office building space newly leased in the City each year.

Compound annual growth rates, a measure of rent increases, in the district will be 0.5 percent the next five years, an eighth as much as buildings in London’s West End, JPMorgan analysts including Harm Meijer estimated in a Sept. 4 report.

That isn’t putting off Asian investors.

“We believe in the strong fundamentals that underlie the City market,” Mitsubishi Estates’ Arimura said. “There is limited speculative development and there is ongoing demand for the highest quality designed buildings.”

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