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Thu 23 Dec 2010 11:35 AM

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London real estate leads world as rents rise

Sales of commercial property in the UK capital totalled $13.9bn in first nine months of 2010

London real estate leads world as rents rise
MOST INVESTMENT: Londons commercial property market is likely to draw the most investment for the 2nd consecutive year (Getty Images)

London’s commercial property market will probably draw the most investment for the second consecutive year as prospects of rising rental income attract cash from as far afield as Hong Kong, Qatar and Canada.

Sales of existing commercial property in the UK capital totalled $13.9bn in the first nine months, more than in any other city, according to Real Capital Analytics. Some of the biggest deals of the year were announced in the final quarter.

“There’s a massive surplus of investment capital looking for a home, and the one thing in common is a desire for yield,” said Dan Fasulo, RCA’s managing director. “A core London office property at a five or six percent yield looks fantastic against the alternatives.”

Cash-rich pension funds, sovereign wealth funds, insurers and wealthy individuals bought shops, offices and even luxury homes in central London as low interest rates and concern that the global economy will deteriorate made other investments riskier and less appealing. The city also ranked first in 2009 with sales of $16.8bn, New York-based RCA said.

In the past two months, Norway’s sovereign wealth fund agreed to pay £448m ($692m) for a stake in Regent Street.

JPMorgan Chase purchased a new European headquarters building for £495m, Dutch and Canadian retirement funds signed an £872m giving them part of the Westfield Stratford City mall next to the site of the 2012 Olympics.

In May, the sovereign wealth fund of gas-rich Qatar bought the Harrods luxury department store for £1.5bn.

“Negative real interest rates mean you aren’t going to buy government bonds, corporate bonds have already had an incredible rally, gold doesn’t give you a yield and the stock market is volatile,” Fasulo said.

Tokyo ranked second after London based on existing commercial property sales in the first nine months, at $13.1bn. Hong Kong was third, followed by Paris and New York. RCA’s final rankings for 2010 are due in February.

If land deals for development are included along with existing buildings, Shanghai attracted the most money in the first three quarters, at $21bn, the data show. About 81 percent of that figure is for development projects.

New York held the top spot in the world for commercial real estate sales in 2007, at the height of the debt-fueled investment boom. It slipped to second place after Tokyo in 2008, and to seventh place last year, RCA data show. In the first nine months of 2010, sales of existing New York commercial property totaled $5.8bn.

London was one of the first real estate markets to see a pickup in deals and prices after the financial meltdown. The recovery began in the second half of 2009, ending two years of declines that wiped 50 percent from central London office values. Property became even more affordable for foreign buyers as the pound dropped. Sterling is now 23 percent below its September 2007 value against a basket of other currencies.

In London’s West End, where office leases cost the most in the world, rental income totals about four percent of a Grade-A building’s value on average.

The ratio, known as the capitalization rate, was 3.5 percent when prices peaked in 2008 and rose to as high as 5.5 percent a year later as the financial crisis caused values to fall, CB Richard Ellis Group Inc. said.

“You saw a huge weight of money coming in from overseas, attracted by the double-whammy of super-cheap pricing and the pound effect,” said Damian Corbett, head of West End office sales at Jones Lang LaSalle.

Investors may start to look away from London in 2011 as property in parts of the US becomes good value again, said RCA’s Fasulo. US deals may double next year and account for almost a quarter of global transactions, he said.

US offices are the most undervalued real estate in the world and investors have almost $100bn earmarked for deals there, according to broker DTZ Holdings.

Fasulo predicts “a wave of new investment” over the next six months in Manhattan worth about $10bn. The average capitalization rate for a prime office building in the borough is six percent, and prices have scope to climb by about four percent, according to DTZ.

London’s reign seems secure for the time being. Corbett estimates that there are 1,000 wealthy individuals looking to buy prime commercial properties in the British capital for as much as £200m, compared with about four in 2008.

Pramerica Real Estate Investors, acting for a wealthy family that it declined to identify, acquired Perella Weinberg Partners’ London headquarters in Mayfair for £47.8m in September. The sale was at a capitalization rate of 3.9 percent, brokers NB Real Estate and King Sturge estimate.

Investors in London expect capitalization rates on properties they own to go up as rents increase, said Jason Winfield, who heads DTZ’s UK sales department.

DTZ predicts that prime office rents in the West End will climb 38 percent to £110 a square foot in 2014 from last year’s low of £80. In the City of London financial district, they will rise 55 percent to £67.50 a square foot. City offices are still priced 10 percent below fair value and West End properties are 5.5 percent undervalued, according to the broker.

The gains have been mainly limited to the capital, RCA data show. Elsewhere in Britain, concern about the impact of government spending cuts to reduce the national debt has held back property investment.

Tenants are competing for the best new office space in London after the financial crisis caused construction to slow. Drivers Jonas Deloitte estimates that office construction in central London is the lowest in at least 20 years, and the prospect of constrained supply has drawn some overseas investors.

Money isn’t just flowing into shops and offices. The euro region’s debt crisis enticed more continental Europeans to seek a “safe haven” in London, where luxury residential prices are 14 percent lower in euro terms than at the peak in early 2008, according to Knight Frank.

“Some of the uncertainties in other cities helped London,” Fasulo said.