Reversal of fortunes
Investors have returned to the City of London office market in a big way, with almost £2bn (€3bn) of property being traded in the first quarter of this year.
According to Jones Lang LaSalle, £1.94bn of stock was traded in the first three months of 2005, the second highest quarterly total in history. This compares with around £5.5bn in the whole of 2004.
JLL city investment director Chris Northam said: “We’ve seen a huge amount of investment activity in the City in the first quarter. This is a reflection of the record weight of money chasing commercial property generally, although the turnover figures have been buoyed by a number of large deals which drifted from 2004 into 2005.
“Prime yields are now at 5.5% and continue to be under downward pressure, both from the weight of money, and the expectation of rental growth returning to the market.”
Dr Karen Sieracki, head of research at specialist City of London real estate adviser BH2, said: “The first quarter of 2005 saw a continuation of investment flows into the City office market. German funds were the most active, accounting for 40% of purchases, followed by UK property companies at 24% and UK institutions at 13%.
“The German funds investment focus was for prime income stock. On the disinvestment side, UK private companies, individuals and trusts comprised the majority of activity at 55%, followed by Far Eastern investors at 12%. The sellers tend to be either taking profit or realising capital for business investment.”
German funds spent £693m in five major deals in the City and surrounding office markets in the first quarter:
n The Lloyds Building, purchased by Commerz Immobilien for £231m at a yield 6.80%;
n 90 High Holborn, bought by KanAm, £135m;
n K2 at St Katharine Docks, bought by CSAM for £127m;
n Riverside House, Southwark, bought by IVG for £107.9m;
n100 Leadenhall Street, Nord Capital, £92m.
German investors have not been the only big buyers. Last month, quoted UK real estate company Land Securities sold its 30 Gresham Street scheme to GIC Real Estate, the Singapore Government’s investment arm, for £274m, representing a yield on income of 5.6%. President of GIC Real Estate, Dr Seek, said: “This is an ideal opportunity for GIC Real Estate to increase its exposure to the prime City of London market.”
The development, which was completed last year, has been occupied by Dresdner Kleinwort Wasserstein. Much of the buying activity has been due to capital markets drivers rather than real estate fundamentals, but both JLL and BH2 see the prospects for rental growth in the City, for prime property at least, improving.
Dr Sieracki said 1.2mft2 (120,000m2) of office space was leased in the first quarter, with pre-lets comprising 19%. More than half (57%) of the total space let was Grade A, which was in line with the long-term average. Overall, total demand increased to 10.3mft2, from 8.8mft2 level at the end of December 2004.
She said the vacancy rate for Grade A office space has now fallen to 5%, which indicates that rents could start moving upwards soon. So far this year though, average Grade A rents remained constant in at £40/ft2. However, Grade B rents continued to be under pressure in the first quarter, seeing a further decline of 3.85%.
BH2 says 4.8mft2 of floorspace was under construction at the end of March 2005, of which 56% was pre-let to tenants. This was an increase of 37% from the end of December, following on from an increase of 52% in Q4 2004. Speculative space under construction increased by 75% to 2.1mft2. As for planned speculative starts, there are potentially 11 schemes comprising 2.1mft2 of which 1.19mft2 is likely to be completed between Q2 2007 and Q2 2008.
Matthew Hammond, a director in City agency at Jones Lang LaSalle, comments: “We are starting to see some developers being prepared to commence speculative construction again. Scottish Widows embarked on a development of 24,940m2 at Aldermanbury Square, EC2 (formerly Royex House) and Asticus has commenced its scheme at 71 Lombard Street (10,920m2). In addition, further established developers such as Land Securities, British Land and Standard Life are seriously considering speculative development of existing holdings.”
The Docklands saw some improvement in the first quarter saw take-up of 9,580 m2, according to JLL, comprising two lettings at 25 Canada Square, Canary Wharf and three at Wyndham House, Marsh Wall. The vacancy rate has fallen marginally to 13.3%.
There were £504.7m of investments traded during the first quarter: Barclays Capital purchased 20 Canada Square for £337.5m and private Irish investors acquired 15 Westferry Circus for around £135m, reflecting a 6.06% net initial yield. And Schroders purchased Independent House, Marsh Wall from Hermes for £32.4m to yield 8%.
Overall the prognosis for the City office market is good. BH2 is predicting Grade A rents will reach £42.39/ft2 by the end of this year, a rise of nearly 5%. And rent-free periods are expected to halve from 18 to nine months. At the end of 2006, Grade A rents are expected to hit £47.14/ ft2. However, some other City of London property advisers are far more bullish and reckon top Grade A rents will hit £52.50 this year.
However, the prospects for Grade B space, which suffers from greater oversupply, are not so good. BH2 expects Grade B rents to fall 3.7% to £24.86 per ft2 by the end of this year and to remain static in 2006. Modest growth of 2.3% is predicted for 2007.
Dr Sieracki says: “There is still a significant weight of money headed towards real estate, on the back of relative performance and risk, together with its yield profile. Prime office stock remains a favourite for future income growth.”