Commercial Real Estate Development - Essay Example

Is supply and demand the major factors influencing the commercial real e development, and regeneration in the Central London area The economic downturn globally has ended up putting a freeze to the real estate development, the world over; therefore it is unlikely to say that demand and supply is the reason affecting the commercial real estate development and regeneration in any part of the world and specifically Central London area. Since there are many factors influencing the commercial real estate, due to diverse range of uses and complicated location, thus, there is huge intricacy involved in valuing various commercial estates. When we talk about commercial real estate, it is referred to commercial retail including department stores, super markets, shopping malls, and hotels, offices, buildings, restaurants, etc. The current trend as indicated in the recently published, Estate Gazette Feb 2009 states the impact of the economic downturn which has resulted in very low pent up demand as not many can afford to do so and who did have already traded . Location, layout, storey of building, area, height, storage space, interior decoration and construction framework, possibility to sub lease, inter changeability of formats, ownership distribution, availability of utilities, central air conditioning, and the level of management fee. Each of these factors will be elaborated in detail further, which will help in correctly inferring that supply and demand are not the sole factors affecting the value of commercial real estate and its development and regeneration. Business Improvement Districts (BIDs) gained popularity because of rising crimes, emerging anti social behavior and the environmental problems. In London this evolved as a quite recent phenomenon where the formal drive occurred for the first time in April 2001. Earlier some private were operating already, but then the government announced its very first. Schemes like Town Centre Management had started in 1980s, which were a part of public private partnerships for the benefit of businesses and other stake holders. Since concept of Business Improvement Districts kicked off as a tool for financing the revamping of residential neighbor hoods. Later Government in the Environment Committee of the House of Commons took up a project termed as town improvement zones, this was a bold move for the regeneration of inner city areas. Then in December 2001, further favor in these kind of zones was given Labour Government's white paper Strong Leadership Quality Public Services and this was in reality the first step towards urban regeneration policy. In 2003 testing was started with some areas - towns and cities, labeled as pilot locations, aimed at discovering the methodology to be adopted in making a Business Improvement District scheme a success; process and experience for managing and evaluating. Following this testing stage, government passed a resolution in 2004. As earlier mentioned, possibility of sub lease affects the value of a commercial real estate development which will now be further elaborated. Since restrictions on sub leasing affects the flexibility of further renting out a property and thus hugely affects. Since there are two sources of return from property - one, the savings that comes in the form of opportunity cost too and another from the rental income that is earned when property is given to be utilized by someone else. And unlike other assets, since property does not depreciate but there is always a hope of potential development and there is always a risk and return that is uncertain how these returns will move in future. All developers and investors base their decisions on number of factors - current income and future return generation capacity. Leasing patterns have a great impact on the development and regeneration of the commercial real estate. This is visible from the 1989 UK's market crash which tended to change the relationship that earlier governed between landlords and business tenants (Estates Gazette). Earlier it was noted that since there were relatively lesser number of business tenants, hence the negotiation power was lower and number of strategies were adopted which included shorter leases, break clauses, capital payments, rent free periods and other inducement to attract the tenants. In 1990s many changes were seen in the UK standard institutional leases. The lease normally had lengthy term, ranging from 20-25 years or more; landlord had more control over the disposal of the lease by the tenant, lease payments were subjected to upward revisions on periodic basis depending on how the open market rents moved. Earlier responsibilities vested with the landlord were transferred to tenants either in physical form or via monetary charges. These included insurance, repairs and maintenance, or any other replacements. These changing trends led to larger developments in the area. But today, the trends are largely changing - modern businesses no more have huge planning horizons, in fact these have shortened to three to five years. Thus, increase in lease terms for twenty to twenty five years brings in huge costs and ties the business for a very long time and brings in larger inflexibility. This nature of lease diverts attention from the main business operations and the clause for one direction (only upwards) was in favor of landlord whereas, tenant was devoid of taking any advantage in times of falling market prices; highly affecting the business profitability. To resolve such problems many products were introduced then such as securitization which led to development of asset backed issues. An example can be seen in Trafford Centre Finance Ltd which issued notes backed by Peel's Trafford Centre regional shopping centre spread over 130,000 square meters and was arranged by Deutsche Bank. 610mn pounds were raised from this issue. Similar to this Canary Wharf Group issued two major secured debts - one was a 550 mn pound Eurobond issue (proof of property market going global) and was underwritten by Morgan Stanley and secured by rental income of the property; a stepped coupon bond and a floating rate note were issued. The three office buildings, retail space and car parking at Canary Wharf were structured from this huge financing. In addition to securitization, sales and leaseback and off balance sheet financing structures gained popularity (Estates Gazette). Shell in 1999, sold 180 petrol stations that were long leasehold to a joint venture between two private property companies - Rotch and London & Regional. This benefited Shell to release capital from the sale and took the assets off its balance sheet and realize tax efficiencies prevailing in the system. More examples follow from Abbey National which is a good example of outsourcing or corporate real estate function. The key drivers for development therefore include the above mentioned two factors. Besides, investment in land increases the productive capacity of the land and hence impacts its value. The more the productive capacity that is the revenue generation ability the higher the chances for development (Estates Gazette). According to the economists, development involves directing the resources in the efficient manner as possible, which results in supplying the most productive properties in specific areas. But on the other hand, development is in the hands of the owner and the land owner has the command over the tenant. Then there are issues with the unit size of the property, since there might not be just one property unit developed, infact multiples together therefore there might not be a balance between supply and demand of the property. Therefore, supply and demand imbalances are most likely to be present all the time, long term shortages increase the worth of the real estate or demand changes occur through relocation or other occupational changes. Investment times frame, planning, regulations, building cost are other factors that determine the value of the development in many cases. Development agencies and administration world wide in major cities constantly struggled for the right incentives to give for the encouragement of development in huge cities. These incentives are aimed to attract private developers to work with public administrations in fulfilling their social and urban agendas. But strict controls are required to direct the development on the right track because of the conflicting interests of the public administrators and the private developers. On one side, where public administrators' target is development of affordable housing by relying on subsidies, private developers are in favor of building more luxury apartments in well off and posh areas where they get support in their other business segments too. But, giving financial incentives for the development of new areas is imperative for the government; firstly, for attracting the developers from the private sector in areas where they have not shown interest in building demand for different real estate products including residential, commercial, office or industrial was important. And more importantly for luring developers in partnering for the development of affordable housing units and public spaces, brining in economic growth, new jobs and better pricing and ultimately, both learned that none can achieve their goals independent of one another. Economic, political and social drivers were the main reason behind the urban regeneration programs that were implemented in London. The ruling party's policies were the determining factor of the direction of the urban policy - the approaches used, funding program and the incentives given. In the 1950s the then ruling Labour Government's focus of the urban policy, a part of duties for fulfilling its role as a welfare state, was on the reconstruction of British cities and towns. Suburban growth and relocation of industry was the concerned area of the national and the local government, whereas, no participation from private sector was thought of at that time. Then came the decade of the 1960s and the policy shift from reconstruction was made towards revitalization of the economy. The Labour and the Conservative Governments that came during this era faced numerous challenges related to growing population and rising demand for housing. The peripheral and urban areas reconstructed after the post war period remained the focus of growth and no efforts were made at rehabilitating the core, therefore growing frustration from unemployment, unavailability of food and shelter led to social and economic decline. To this frustrated environment in 1968 the State Home Office, responded by initiating an Urban Programme, under this government resources were directed towards the severely deprived areas; approximately 75% of the project cost was to be funded by the Government and the remainder was the responsibility of the local authorities. But all these efforts made in the past two decades were a failure for the economy. Later in 1970s policy makers identified that the cause of the failure was independent social, economic and physical policies; hence efforts towards integrating the three was the core idea at which attempt was made. Thus, major problems the state was undergoing were identified. It was inked that low incomes, unemployment and housing problems were increasing urban poverty which was spread over a long term period; in addition concentration of racial minorities in centres like London and Birmingham was increasing. A typical bricks and mortar approach of urban regeneration was replaced by emphasis on urban poverty and economic revival and given was The 1997 White Paper: Policy for the Inner City was developed which was followed by Urban Areas Act 1978; in this for the first time ability of private sector was recognized. Since the recognition of partnership was in early development stages, criticism was made on the funding terms, allocation and the way these partnerships were managed. The 1997 White Paper Policy pointed out the fact that the present deteriorated condition of the inner cities was because of decline of the economic establishments; where the need for stakeholders such as public authorities, non government and non profit companies was emphasized and a growing need for enterprise culture was configured. For luring of private sector into developmental projects, the Government in 1982 gave capital in the shape of Urban Development Grants for project that involved partnerships of local authorities and the private sector, there was no restriction on the kind of project to be worked upon. Aim was to leverage up to the optimum level the funding from both private and public sector investors. In conjunction with Urban Development Grants, Urban Regeneration Grants were also given to encourage bringing in major schemes by the private sector. Later City Grant were given which was an amalgamation of Urban Development Grants and Urban Regeneration Grants and that gave rise to an Action for Cities Programme; pure participation from private sector was there which excluded the role of local authorities as request for grants was evaluated by the private sector and awarded directly to the developer. In addition to Urban Development and Urban Regeneration Grants, other initiatives included Urban Development Corporations and Enterprise Zones. The Urban Development Corporations were empowered with transforming areas by putting buildings and lands to use, create industry and not only focusing on the physical infrastructure but also altering the environment and making it conducive for working and living. The Urban Development Corporations managed their funds and had decisive powers to cater to the needs for the regeneration of buildings and lands in assigned areas. Then in 1998 all Urban Development Corporations were dissolved and authority was vested to the newly formed agency, the English Partnerships. The Enterprise Zones were the pilot testing projects which did not have much of development controls and regulations, the aim behind was the encouragement of aesthetics and beautification of the urban centers. For promotion of such economic zones, relief was given in the shape of null development land taxes or for exemption for a certain number of years and in some cases even 100% allowance was given. Then came the 90s where Regional Development agencies and English Partnerships were created and flourished. These agencies were acting as middlemen between various stakeholders inclusive of public sector, private sector, community service agencies, and other voluntary and involuntary functioning organizations. Schemes like Single Regeneration Budget were initiated in 1993 to integrate all regional integration programmes into one. The City Challenge Fund was another largest urban policy budget that were based on the long term and forward looking public and private sector partnership. This historical overview tells that demand and supply were not the factors on which development and regeneration of commercial real estate was based. Combined economic, physical and social policies led to changing framework in this area; where not only the local authorities, state, or the private sector could have done anything on their own. One huge example of large scale development and massive regeneration plan is Thames Gateway Initiative in London which was the largest regeneration project in Western Europe. The project had its basis on the financial incentives as a collaborating point between the planners and the developers of the London City. It was the London Thames Gateway Development Corporation that took over the target of funding 40,000 newly build and developed homes and creation of 28,000 new jobs in the city. The areas selected for the project were the prime growth areas of the London city, namely, Lower Lea Valley and London Riverside. The Thames Gateway project was an alliance between 12 local authorities, the London Development Agency, multiples of universities, 2 strategic health authorities, and the East London Learning and Skills Council. This project was one of the growth areas of the London Plan, the growth and regeneration was planned in areas for building additional rail capacity for meeting the excessively growing demand for rail transport; with this growing demand other addressed areas were significantly suppressed demand for services, further provisions were made for future and projected levels of growing demand. Some of the options of financial incentives considered in the Thames Gateway Initiative were issuance of tax exempt bonds, whereas, some incentives purely made available to the private sector are lower permit application fee - where the developers benefit in less time and less cost resulting in higher and successful investments whereas, the tax increment financing is the financing provided on the anticipation that the municipality will earn higher taxes from new businesses. These were the incentives provided to the developers; other incentives were also targeted at businesses and tenants to attract them to new areas which were earlier disrupted by the development activity. Interest created by the private sector facilitated attraction of the venture capitalists, which became additional funding sources in form of soft loans, equity investments and also provided expertise in areas of technology, recruitment and sector specific knowledgeable skills. Government grants were also available for the businesses. The London Thames Gateway Development Corporation provided various types of commercial incentives in the form of tax abatements. These incentives provided were: A five year reduction from commercial rent tax for large employers Exemption from sales tax for lease improvements on newly signed leases for 10 or more years Deductions in corporate taxes for employees relocated to the city from other company headquarters These financial incentives were a part of the public administration policy fulfilling government's role as a welfare state. Overtime we have seen that trends of real estate development and regeneration has changed - the main reason of change as apparent was changes in property financing from only banks to venture capitalists and other private investors and developers as well. Further, global economic forces have also affected the way commercial real estate development and regeneration took place. Most importantly, globalization of world, has affected the self containment of the domestic property which was the case earlier. Inter country and across the border transactions, development of global stock markets have all impacted the lease patterns, the way property is brought and sold. The sources of financing have also become global. Earlier the main deterrent of real estate development was illiquidity. Then there was growth in global securitization market, where supply became the major factor to match the demand; which was because of taxation and regulatory problems. In London City, research has indicated that foreign ownership in the city increased from 5% to 22% in a period of a decade; today not only UK Firms, but Middle Eastern firms, and other European firms plus German and US based companies have their offices. The de regulation supported this growth, world over stock exchanges including the New York Stock Exchange abolished the minimum commission rates, exchange controls were abolished and more simply financial borrowing and lending become global. Read More