Concrete Assets

WEALTHY INDIVIDUALS SEARCHING FOR TANGIBLE INVESTMENTS ARE INCREASINGLY TURNING TO PRIME COMMERCIAL PROPERTY. JAMES ROBERTS LOOKS AT THE SECTORS AND LOCATIONS ATTRACTING THE MOST ATTENTION

Commercial property markets around the world have seen a rebound in purchases over the past two years by private wealthy individuals taking advantage of the price drops that occurred during 2008 and 2009.

In 2009, $41.6bn of private money was invested globally in commercial property, according to Real Capital Analytics. This jumped to $57.4bn in 2010, and rose to $70.6bn in 2011. This is quite remarkable considering the fall in investment seen by some other asset classes in 2011, as investors responded to mounting uncertainty in the global economy.

That the in-flow of money increased in 2010, a bullish year, but was maintained in 2011, a bearish year, suggests private investors view buying commercial property as a long-term strategy, not just as a recovery play.

“Property has seen investors conducting more due diligence when selecting assets, but the deals are still happening,” says Jeremy Waters, International Investment Partner at Knight Frank. “Private investors with a wide range of nationalities are acquiring commercial property, with a large percentage looking to do so outside their own countries. This is about securing income streams and diversifying investment portfolios.”

Knight Frank expects further growth in investment from wealthy individuals, forecasting a purchase volume of $74.1bn in 2012, a 5% year-on-year increase, as investor caution favours the safety of bricks and mortar.

With the global economy still in an uncertain place in 2012, property has obvious attractions for a private wealthy investor, says the firm’s Peter MacColl, Head of Global Capital Markets: “We expect the flow of capital into the UK and core European capitals to continue so long as they remain a safe haven for investors and the currency advantage continues. Investors are conscious that, although times are difficult, a turning point will come for the economy sooner or later. Property purchased at current prices will look like a shrewd investment by 2013, when the world will have moved into a new economic cycle driven by emerging markets and digital technology. This should drive leasing demand for commercial property and push up rents, delivering further upside for investors.”

Many investors from emerging markets have taken advantage of favourable exchange rates to buy commercial property in developed nations. This, plus the price correction that occurred in 2008 and 2009, has allowed more emerging market buyers to pick up trophy assets in prestige markets at prices well below those seen five years ago. While values recovered in 2010 and early 2011, the recent economic slowdown and uncertainty in the eurozone have created another buy-in opportunity.

“Every successful business person has a degree of experience in dealing with commercial property, as they will have acquired and managed business premises during their career, whether offices, shops, or industrial units. So this is a way of diversifying their investment portfolio, but in an area in which they have some background knowledge,” says Alistair Elliott, Head of Knight Frank’s Commercial Division. “For investors, property can offer the steady income associated with bonds, but with potential upside should rents increase.”

LONDON CALLING

HNW investors have been focusing on London in recent years, attracted by its perceived status as a safe haven and taking advantage of the relative weakness of sterling. Many international buyers have English as their second language and feel confident to deploy funds there.

Commercial property prices have increased in London, with prime yields dropping around 200 basis points since early 2009. This is partly a weight of money story: when investors become concerned about the outlook for their home market, often the first overseas market they will consider is London.

“I advise foreign buyers, mostly from the Far East, who want to buy in London,” says Mr Waters. “Those who are new to the market assume that they will find discounted prices and are often surprised at the high level of competition from other equity buyers.

“For an investor who is new to London it is safest to buy the best, namely prime assets in core locations. This means accepting lower returns than on riskier assets: 3.5% to 4.0% in Mayfair and St James’s, 5.25% for the City, the core financial district. In the future, I believe the more experienced investors will want to look at redevelopment opportunities where stronger returns are on offer. Many of the sophisticated buyers are setting up offices in London to manage and expand their portfolios.”

The numbers demonstrate investors’ enthusiasm for commercial property in London. The volume of funds invested was £9.1bn in 2011, which is lower than 2010’s figure of £10.3bn, but considerably higher than the £6bn invested in 2009 and £6.7bn in 2008. A growing reluctance on the part of owners to sell acted as a brake on activity in 2011, leading to competitive bidding for assets, particularly upmarket retail.

“Private investors have been applying commoditylike pricing to Bond Street shops, buying them almost entirely for their wealth storage capacity, with little consideration given to the yield,” says Ker Gilchrist, Head of West End Investment at Knight Frank. Investors have pushed Bond Street yields down to just 3.5%. However, to some buyers from Asia Pacific this appears attractive compared with yields on commercial space in their home markets – prime retail yields in Hong Kong are 3%, and prime office yields are 3.2%.

Motives are wider than just securing income, according to Tiong Cheng Tan, Chairman of Knight Frank Singapore. “In Asia Pacific some national governments are acting to slow the housing market, while private wealthy investors are bearish on residential property prospects in the near term. This has encouraged them to look abroad to diversify their portfolios. Wealthy individuals from Hong Kong and Singapore are interested in investing in London as it is a market they feel confident with and where they encounter similar legal structures and business practices.”

OFFICE AND HOTEL INTEREST

HNWI interest in London property stretches beyond just retail, according to Mr Gilchrist. “Wealthy individuals are applying this commodity-like approach to pricing to office buildings in Mayfair and St James’s, which is considered London’s most prestigious business district, and contains addresses like Berkeley Square and Piccadilly. Some people say buildings in Mayfair and St James’s are the gold bullion of the property world, but I would argue they are better investments than precious metals. An office building brings in rent every three months, whereas gold is purely about capital value.”

A Middle Eastern investor recently paid £10m for the freehold of 5 Stratton Street, a Mayfair office building, which equates to a 3.6% yield, drawing close to the yields achieved on Bond Street shops. However, obtaining a freehold in Mayfair is difficult as the market is dominated by estates and private owners who rarely sell.

The popularity of West End offices means supply is dwindling, encouraging buyers to look elsewhere to secure high-quality buildings. The neighbouring City market is benefiting. “It is a different sort of wealthy private investor who looks at the City rather than the West End,” says Stephen Clifton, Head of City Investment for Knight Frank. “The average lot size is larger, so it requires deeper pockets and a willingness to deploy more funds in a single deal. In the City, private buyers will find themselves competing against more institutional investors. This means the market is better suited to those with greater experience of property investment, in order to bring out the greatest potential from the assets and thus draw the best possible return.”

A good example of this is the recent purchase of Tower 42 by southern African investor Nathan Kirsh. The building, one of London’s most iconic, is multi-occupied, mostly by tenants on short leases. In the near term Tower 42 offers the new owner a 7% yield, at a time when UK government bonds offer just over 2%. In the long term there is the opportunity to refurbish the building and achieve premium rents – upper floors in towers in the City normally let on rents that are 5% to 15% higher than low-rise buildings, depending on quality.

Hotels are another investment magnet in London, attracting capital from the Middle East, India and the Far East, according to Dominic Mayes, Head of Hotels and Leisure at Knight Frank. “We are seeing significant interest from private family investors who have experience of hotels and hospitality, and are familiar with the cyclical nature of the hotel industry. They are seeking presence in safe and secure markets, hence the interest in London.” Singapore real estate company KOP, for example, recently bought the Cranley Hotel in South Kensington, which had a guide price of £14m.

GLOBAL HOTSPOTS

Paris has also traditionally been popular with foreign buyers. Investors regard it as a big, international city that can offer office and retail assets let to strong covenant tenants, typically at inflation-linked rents. Prime office rents in Paris have increased by approximately 17% since their low point in late 2009, and currently stand at €830/ sq m, while shop rents on key thoroughfares like the Champs-Elysees are up 14% to €8,000/sq m.

While the French capital is currently linked psychologically to the eurozone crisis in many investors’ minds, it is still a perennial business and tourist location, and a centre of government. This could make it an interesting opportunity for an investor looking to buy against recent negative sentiment on the outlook for the French economy. Likewise Germany, with its relatively low unemployment, is demonstrating that it is a comparatively strong economy, despite problems elsewhere in the eurozone. Frankfurt offices offer a 5% yield, compared with less than 2% for German government 10-year bonds.

Among private investors, the choice of which markets to buy into is sometimes shaped by lifestyle, says Mr Waters. “Investment follows the locations where HNWIs seek education and healthcare services. Education tends to favour the UK, Germany does well out of healthcare.”

Madrid is seeing investment interest in commercial property from local HNWIs, as shown by retail entrepreneur Amancio Ortega’s purchase of the Picasso Tower for €400m. Wealthy Spaniards perhaps regard property as a safer place to hold money than government debt at present, and local knowledge and contacts will help them reduce the level of risk they are taking. However, entering the more embattled European markets now would be risky for a foreign investor.

Activity by private investors in the New York commercial property market has been dominated by local family buyers restructuring their portfolios. The Rudin family recently consolidated the ownership of One Battery Park Plaza by purchasing the 50% stake held by the Rose family. The Roses want to concentrate on residential property. Jared Kushner has also sold a stake in 666 Fifth Avenue to Vornado Realty Trust, creating a joint venture between a private investor and a real estate investment trust.

With its robust economy, underpinned by mineral wealth, Australia has been attracting foreign private money. Memocorp, the Australian vehicle of Singapore billionaire Tay Tee Peng, paid AU$395m for 259 George Street in Sydney. South African investor Nathan Kirsh, who has also been active in London, bought 4 and 14 Martin Place for AU$153m. Economic indicators for Australia read well compared with other Western economies. The country has an unemployment rate of 5.2%, and public debt estimated at 7.7% of GDP for 2011, according to the IMF. “If China continues to grow and commodity demand remains, there is a growth story for property in Australia. We are upbeat on prospects for cities like Perth and Brisbane that have strong links to the mineral and mining industries,” says Stephen Ellis, Executive Chairman of Knight Frank Australia.

Currently, the flow of investor money is mainly East to West, though Knight Frank’s Tiong Cheng Tan says next year the focus may revert to the East again after house price pressures have eased in the region. “In the long term Asia-Pacific investors will want to spend funds in home markets once the current slowdown has passed. However, I do expect more investment to flow from the East into the West, as there is still the untapped potential of wealthy investors from Greater China yet to enter the international market.” The trend of growing private buyer interest has a lot further to run.