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Sun 2 Nov 2008 04:00 AM

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Gulf money sits on the sidelines

Arab investment in commercial property in Europe could decline as the real estate market slows.

Arab investors have long been big players in Europe's commercial property markets. Yet that may be about to change as the real estate market begins to slow.

London's west end, with its plush offices and 250 year-old Georgian town houses, has for years been high on the shopping list of wealthy Arab property investors, keen to get a firm foothold in what is one of the world's most sought-after real estate hot spots.

High demand among wealthy hedge fund groups and very limited supply has pushed prices and rents ever higher over the last decade. More insulated from the property downturn than other parts of the UK, Central London continues to provide solid returns for investors attracted to the relative steady returns offered by long leases.

The conundrum facing all types of investors in a real estate slump is when to call the bottom of the market.

But demand from Arab investors for the high-end properties of Knightsbridge and Mayfair is now starting to wane.

Typically, Arab money is behind between 5 percent and 10 percent of the total commercial property deals in London's West End, and around 3 percent in Paris.

Unlike the German institutional funds and Irish syndicates, who are some of the biggest investors in London, Gulf money doesn't dictate the market but still remains an important part of cash flooding in from abroad, according to local brokers.

Deals in London's financial district, the Square Mile, and its fringes over the last year - such as the Qataris' rescue of the $2.2bn Shard of Glass project and the Kuwait Investment Authority's (KIA) $627m acquisition of flagship office tower the Willis Building - have shown Arab money will go after trophy assets, even if they were considered expensive at the time.

But now signs are emerging that investors from the region are becoming more cautious, anticipating further declines in property valuations.

"They are lining up to buy but waiting for the market to stabilise and seeing how things play out," says Stephen Hubbard, deputy chairman of CBRE for Europe, Middle East and Africa.

Hubbard expects activity will pick up again at the start of next year when prices, albeit some 30 percent down from their peak in the summer of 2007, may have started to stabilise.

And it is pricing that seems to be the main concern among Gulf investors right now, according to Bob Hird, who heads up Middle East investment for CBRE in Abu Dhabi.

"They are being very selective and waiting for the opportunity. The problems they are facing is pricing: nobody knows where pricing is. There have been very few investment sales of a major nature this year in London," he says.

Hubbard estimates that commercial property values have declined by as much as 20 percent in the last year in the UK, with rents in the City of London falling from $104.30 per sq ft to $88.16 per sq ft over the same period. Alongside this, yields have softened making returns for investors that more attractive.

They have moved out from around 4 percent in central London to above 5.5 percent in some cases, as seen when a private Middle Eastern client bought 15 Berkeley Street in Mayfair, London, for $49m in August at an initial yield of 5.72 percent.

Equally, the conundrum facing all types of investors in a real estate slump is when to call the bottom of the market. Both Hubbard and Hird agree it is impossible to tell when the bottom of the cycle has been reached, until prices start to rise.

It is this uncertainty over pricing, driven by the wider uncertainty over the longevity of the global economic downturn, that is causing investors to buy on sentiment.

Paul Cockburn, head of West End investment at London-based property adviser Savills, says Gulf investors will buy when the market improves, not while things are still gloomy.

"They are buying on sentiment, rather than pricing. They are not going to say, that looks good at 6 percent [yield] or that looks good at 5.5 percent, they are going to say, the market is going down, we'll come back in 12 months time.

"If the market is saying 5.5 percent after a year then they will probably come back in, just because it is a good time to buy."

According to Savills, Middle Eastern money has been behind 11 out of the 110 deals done in the West End in 2008, making up 10 percent of the market. This represents a small rise on the previous two years.

In 2007, 6.4 percent, or nine out of 188 buildings in the West End were sold to Middle East-backed purchasers, while in 2006, 15 Middle Eastern-backed transactions out of 223 were recorded, constituting 6.7 percent of the total market.These trend-bucking figures appear to show that despite the onset of a world financial crisis this year and a deepening liquidity squeeze, Gulf property investors in the UK have been relatively undeterred.

But with real estate stocks taking a pounding in the GCC recently, Hubbard argues money arrives in the UK during times of volatility elsewhere in the world.

"In the last 15 years, money comes over here in times of uncertainty. Rather than in a steady trickle, money tends to come over here in fits and bursts," he says.

There is nearly no Gulf investment here, apart from hotels. Arabs have historically paid any price for whatever they want to buy, but now this is not the case.

The ongoing banking crisis, which has put equities across the world into freefall over the last month, may also be controlling direct property investment in the UK from the Middle East.

"Many people are nursing some quite big losses on the stock market, particularly those that went into the banking sector. This is a global issue.

"People went into that sector too early, so there is a reluctance now to go into anything too early because we are in uncharted territory," Hubbard continues.

In Paris, Arab investment has all but ground to a halt. There have been no purchases of office buildings this year, unlike 2007, according to Samer Honein, head of Middle East investment at Jones Lang LaSalle in Paris.

"There is nearly no Gulf investment here, apart from hotels. Arabs have historically paid any price for whatever they want to buy, but now this is not the case.

"London is on their shopping list, it is cheaper compared to Paris," he adds.

Honein's Gulf clients have told him they would only be interested in purchasing a building with a yield of 5 percent or more. Most deals coming to the market are developments with a yield of 4.25 percent or lower in Paris.

Luke Condon, who works on investment in property agent Knight Frank's Paris office, says the Dubai-based sovereign wealth fund GIC is waiting to pounce on an asset throwing up a 6 percent yield in the Paris market.

Although there have been no acquisitions of commercial real estate this year, there is continued Middle East interest in trophy buildings in the main Paris CBD (central business district), around the Champs Elysees, Honein explains.

The only Gulf-backed deal in Paris this year has involved Saudi-owned MBI International, which signed an agreement on Oct 26 to buy 12 French hotels from Starwood Capital, in a deal worth around $2bn.

Unless European real estate markets show signs of rebounding, it may be the last big deal involving an Arab investor for some time to come.

LOOKING EAST: Deals in 2008January:A consortium backed by Qatari investors acquired an 80 percent stake in the 310-metre mixed-use Shard of Glass development, south of the River Thames by London Bridge Station, set to be Europe's tallest building when it is built in 2011.

A group of four Qatari investors led by the Qatar Islamic Bank and newly established Islamic investment bank QInvest bought a 20 percent holding in the $2.8bn project alongside Sellar Property Group.

May:St Martins Property Group, the real estate arm of the Kuwait Investment Authority (KIA), paid $642m for the 491,000 sq ft City of London office tower, the Willis Building. It is let to insurance broker Willis, and the deal reflected a yield of 5.7 percent.

June:Fund manager Hermes Real Estate sold 45,000 sq ft 3/5 Burlington Gardens in Mayfair to asset manager EPIC for $120.3m, on a yield of 4.05 percent. Middle Eastern money was understood to have backed EPIC.

Aug:A private investor, believed to be Middle Eastern, bought 15 Berkeley Street, an office building in Mayfair, for $49m, reflecting a yield of 5.74 percent.

September: Private London-based Stow Securities bought Claridge House on Davis Street in Mayfair for $25.3m, reflecting a yield of 5.2%. It is thought Stow was backed by a Lebanese investor.