Investing in London Office Market - Case Study Example

ment of Objectives: This property investment has been prepared for a famous Asian high tech company which is interested in investing the London office or commercial property for using and letting. The company is expecting growth in the value and different development opportunities in the long term. The London office market is highly attractive and is able to overcome different challenges and issues (Savills, 2012). Methodology adopted to analyse the London Office Market: Different macroeconomic and microeconomic elements have been explored and analysed in order to analyse the overall London office market. It is important to carefully analyse different elements influencing the market before investing in it in order to make sure that the investment is profitable in long run (Ball, Lizieri, and MacGregor, 1998). For this purpose, the economic, political, institutional, social, legal, and many other factors are explored and investigated to understand and comprehend the future implications for the London office market. Apart from this the supply and demand and other important elements like property planning and pipeline projects with reference to the different regions and breakup of the overall London office market have been explored and analysed in order to get better understanding of the overall market and industry. Overview of the Main Contextual Factors influencing the London Office Market: Economic Factors: London is considered as major financial hub not only of UK where major business giants are operating their businesses. It is considered as one of the command sector of the global economy. This feature of London makes it more appealing city for foreign investors. London economy can be best measured through Gross value added (GVA) which demonstrates the contribution of not only individual industries or sectors but also the individual producers present and working in the boundaries of London. The GVA also measured the income generated from employment by production of goods and services. The latest data of Gross value added produced by ONS in December 2011, London contributed 21% of the whole UK and per head which is around £35,026 (more than £15,000 than UK average) in 2010 (The Guardian, 2012). (The Guardian, 2012) According to the research conducted by the city group, London is likely to have more GDP than any other city in the world from by 2025 due to its exceptional growing financial service. Currently it is the one of the tenth largest GDP contributor in the world in term of US dollar. A recent research conducting for London offices shows that almost 60% of the commercial property investment in central London was made by foreign investors from 27 countries in 2011 which is considered as very huge comparing with any other world city. While until may 2012, 65% of the investment is from foreign investors which include 13 giant deals. This shows that despite of euro zone crises, London economy boosting rapidly not from the domestic investors but also from foreign investors. According to the research the future prospects of London is looking good for the foreign investors. (Savills, 2012) Due to the global uncertainties, the international investors are now more reserve and investing more in commercial and residential property of London. Even in the debt crises of Europe, the borrowing cost of the UK remains unchanged to 0.5% which shows its financial stability. 10-year government bond yields in the UK was 1.73% comparing with 2.69 in France, 5.79% in Italy and 6.42% in Spain at the end of June 2010 (Savills, 2012). Further, since 1989, the average rate of inflation in UK remains 2.8% which is considerable good for every economy because the purchasing power of the people living in UK is healthy. It shows the opportunities or the investors who wants to invest in UK especially in its financial hub i.e. London (Savills, 2012). (Savills, 2012) The leases in the UK are landlord friendly. The rents are triple net and are always upward and the length of the lease is also long. It is also the reason to attract foreign investors for investing in its real estate. Many foreign investors have their European head office in London. Currently, there are 20,000 foreign companies operating their businesses in London in which there is a large portion of blue chip companies (Savills, 2012). The FDI in UK also shows the confident of the investors where seven deals of 100,000 sq of properties were accomplished by the foreign investors in 2011 (Savills, 2012). The taxation system of UK is very much controlled by the government. The new top bracket of income tax is 50%. However, according to official resources of UK declared that it would be 45% from April 2013. It means the top tax rate of UK would be 15% more than G7 average tax rate. The resources also announced that they will also bring down the corporate tax rate from 26% to 24% in 2012 and 23% by 2013. It is also very good news for the upcoming investors (Savills, 2012). (Savills, 2012) The experts believe that the major challenge that the London might face in the future is new Regulations by the government and housing shortage. The UK government has taken certain steps for the improvement in housing building sector and thinking for incentives which will encourage investors to take risk (Savills, 2012). Europe accepted that the current credit crunch in euro zone has been caused by regulatory failure. Therefore new more tight regulations have been developed to avoid future credit failure. The new regulation is a joint initiative by UK and EU governments. This regulation creates a major challenge for London (Savills, 2012). Demographic Factors: London is considered as the city where young imports and old exports. In 2011, the population of London city was 8.14 million which was noted 7.56% in the mid of 2007. London shared 37% of the England’s total population between 2009 and 2010. The increase in the population of London city makes it more fruitful for the investors as more population means more business and more growth. The population of UK is divided into three segments: 0-14 years: 17.3% 15-64 years: 66.2% 65 years and over: 16.5% The figure shows that the there are more people fall in the age between 15-64 years. People between this age, are able to work. There is a great man power in the UK which is a good for the investors to invest in it. According to the UNDP report 2011, the literacy rate in UK is 99%. The education level of the UK especially London is considered as the best in the world. People from all around the world come in London for education. There are many great universities in UK specially Oxford university which is among top 10 universities of the world. The graduates of these universities are efficient and capable to work on a challenging environment. Political Factors: The politics of a country can bring any news whether good or bad for the investors. The government of UK has always supported for the investors. They always ensure them high return and the profitability in the business. By considering the growing unemployment situation in UK, the current government is very keen to stimulate employment. Those people who are not getting jobs, the government is offering them “New Deal” package in which government funded employers provide training and development to them. The government is like to cut the corporate tax rate to 23% by 2013 which is currently 26%. The current government is also making such policies supporting international exports from UK. Cultural Factors: The London city is a rich of festivals. People of London are food lovers. There is an international food festival called International food festival held in UK every year. People like to cook and eat new and delicious food. The obesity rate in London is over 6.6 million. Other festivals include home country London Fringe Theatre Festival, London Live Arts Festival. The people of UK are Arts lover. They love Arts specially music. They also like to go on other entertainment festivals like an art gallery. Further, spending pattern in UK is increasing day by day. People like to spend in food and entertainment more than any other area. Analysis of the Current and Prospective Performance of the London Office Market Sector: Investment in commercial property is a hard-line decision for business for it is a major factor that decides the future of business. Investment in property is directly related to GDP growth of town and so investment in London is influenced by economic recovery of UK along with the decisions pertaining to settlement of Euro-debt crises. London, though, has also not been able to break away itself from double-dip depression; however, overall forecast shows positive signs. Moderate growth forecast for London in 2012 with 0.3% p.a growth, is expected to be on run way in 2013 while take a flight in 2014 in connection with employment figures improving ( as given in forecast below 1). Earnest and Young also provides data evidencing business looking for presence in London despite decline in corporate investment. This positive outlook is expected to continue for London providing continuous business supportive environment, being hub for business markets and financial services. Hence, attractiveness lies in investment property in London due to competitive edge this destination enjoys over many other investment destinations and avenues. (CBRE Research, 2012) Throughout London has been an appetite for business investors while being characterized by combination of local and foreign ones that remained there with changing major shareholder. Given below provides quick review of investment theme along with information pertaining to amount invested showing sustained pattern except bubble of 2007 (LaSalle, 2012): (LaSalle, 2012) This appetite for commercial investment especially by foreign investor generated for proving secure investment with the income quality for major business centre while support lend by rising Arab crises is also considerable. London’s magnetism is also characterized by its liquidity with saleable property even in the worst market conditions and stock replace-ability, regulations including lease length, tenure, professional consultancy, transparency and tax system. Currency getting competitive with, on a lighter note, familiarity as being centre to various cultural and language centers all strike a good balance on bringing London on high end investment option. Overall property investment and development order in London can be divided (and viewed in image given below) into four sections broadly; West London, Midtown, City and Dockland. (EC Harris) And facts about them have been provided for the purpose of comparison: THE CITY Research evidence that city areas has been most attracted one with sharing 60 percent of developing area (3). Most projects being developed here are of huge size with threshold date in coming four to five years. To mention few, Leadenahall Building, 100 Bishopsgate and 20 Fenchurch Street etc are huge construction which depends highly smooth running of construction being supported by financial solutions. This site also characterizes small constructions that are more expected to be on board (CBRE Research, 2012). This site has more of new construction than refurbishing option chosen for other parts. Change in status summary as of second quarter of this year is as follows: (CBRE Research, 2012) Sectors that dominated the area remained from banking and finance with total take-up segregation given in figure: (CBRE Research, 2012) FORECAST: rents are forecasted to increase in year 2013 from the level it has maintained due to expected start up of business with high tendency to affect market dynamic (CBRE Research, 2012). (CBRE Research, 2012) MID TOWN Site mainly for smaller developments and bigger part of land here is opted for refurbishing buildings than other areas. It was observed to be most performing side of the town with TMT sector dominance and three major deals were taken up that accounted for 75% of total in second quarter. Change in status summary as of second quarter of this year is as follows: (CBRE Research, 2012) FORECAST: with forecast to be most strong in central London, Midtown is expected to perform at 5% in rest 2012 depending upon favorable market conditions. It will get some balancing in year 2013 with greater number of completed projects (CBRE Research, 2012). (CBRE Research, 2012) WEST END This site carrying diverse tenants has more construction confronts. Therefore, the construction is relatively is less here. Anticipation of weak economic activity dragged activity down and largest deal that marked quarter was Debanham’s acquisition at Brock Street, Regent palace (CBRE Research, 2012). Change in status summary as of second quarter of this year is as follows: (CBRE Research, 2012) Business and service sectors categorized as three main acquisitions among top five while rest included manufacturing concerns and consumer services. Given below is the segregation of total: (CBRE Research, 2012) FORECAST: increase in supply has weakened demand; however, year 2013 is forecasted to have better sentiment from occupier as projects on completion are expected to deliver in next two years. It also has incentive of 18- 21 months’ rent free on 10 year lease in core area whereas 21-24 month free rent in out-skirts (CBRE Research, 2012). (CBRE Research, 2012) DOCKLAND Dockland has been less in the overall investment, however, recent acquisition of Financial Ombudsman Services (CBRE Research, 2012). Change in status summary as of second quarter of this year is as follows: (CBRE Research, 2012) Less activity was observed with dominating sector being TMT that comprised of more than 80% of the transactions (CBRE Research, 2012). FORECAST: With prime rents remained stable, with demand to remain suppress due to pressure of weak economic outlook especially from financial sector (CBRE Research, 2012). (CBRE Research, 2012) Comparison Four sections of London have been posed to comparison. Each carries its own strength. City has high construction most demand but at the same time the impact it receives from global economy especially the financial sector development is high. Mid town characterized by high level of small projects is also an attractive avenue as small projects get lesser severe impact from global jerks. Every section also has its dominant sector; therefore, investment in any of the section shall also receive consideration from said perspective. It benefits the legal familiarity and convenience. Discussion of Opportunities and Risks faced by the London Office Market: Risks: In order to come up with better decision regarding the investment in the office market of London, it is essential that the investors carefully analyse different opportunities and risks associated with this. The risks can be divided into two broad categories i.e. systematic risk and unsystematic risk (Sayce, Smith, Cooper, and Venmore-Rowland, 2006). The systematic risk is derived from the market factors and is not controllable by the investors like economic risk, regulations, inflation, tax, and other related factors. On the other hand the non-systematic risk is derived from the factors specific to the investment and can be diversified (Hoesli and MacGregor, 2000). It is better to invest in a diversified portfolio of office property rather than investing in any one or single office property. This will facilitate the investor in the process of avoiding and diversifying the risk. The risk in the London office market can be divided into different categories like (IPF, 2007): Property Risk Location Physical Characteristics Tenants Lease Length Market Risk Market Yield Sector Risk Rental Growth Stamp Duty Land Tax Product Risk Liquidity Diversification Price Volatility Geared Investments Tax Risk Some of the main risks which can directly influence the investment in the London office market are: 1. Currency Risk: There is increasing fluctuations in the value of pound sterling. Although the relative decrease in the value of the pound sterling in previous some years have encouraged different foreign investors to invest in the London office market, but still the fluctuations in the value of the currency result in imposing serious risk for the investors. At the same time it is important to acknowledge here that the cost of hedging is high (LaSalle, 2012). 2. Political and Legislation Challenges: The political, legal, and financial regulations can directly influence the future investment in the London office market. It is being predicted that heavy legislation and financial regulation will in turn destabilise the real estate market. Implications of such strict regulations on the London office market will not be much in short to medium term but will be high in long term. Along with this the Solvency II and Basel II on one hand will provide with more investment opportunities but on the other hand will also negatively influence the confidence of the investors in the London office market (LaSalle, 2012). Apart from this it is being perceived that there are high chances that the government of London with the help of planning reform will increase the residential property at the cost of the commercial property and this in turn will negatively affect the London office market. Also there is a risk that other cities leave London behind in the infrastructure development and make it less attractive for investment (LaSalle, 2012). 3. Relative Value: One of the big risks to the London office market is the relative value of the London city in comparison to other cities and places. This in turn can affect the yields from the property. In the previous years there have been decline in the yields because of the capital weight so there are chances of compression in future also. This risk can be overruled by the analysis of the yields for the next five years. In the next five years there, despite of certain changes in the value of the capital, there will be no strong implication on the yield, as shown in the figure below: (LaSalle, 2012) Overall the London office market has low to minimum risk and it is being predicted that the market will grow in future. Opportunities: The London real estate market in general and London office market in particular offer different benefits and opportunities to the investors. Some of the benefits in this regard are as follow (LaSalle, 2012): 1. Global Financial Centre: London is the international financial hub and this positively influence the real estate market of the city 2. Liquidity: it is perceived that exit strategy is always available, even in the worse situations. 3. Stock: London city is the second largest market in whole of Europe and there is around 2.7 percent stock replacement rate. This in turn increases the investment opportunities. 4. Lease Lengths: the London office market is providing the investors with different opportunities like longer leases. This in turn makes the property investment attractive. 5. Transparency: there is high transparency and all information and data is readily available. According to the Jones Lang LaSalle Transparency index, UK has the third most transparent real estate market all over the world. 6. Tax: there are different leverages and investor friendly taxes in order to encourage more investment in the London office market. All this factors contribute in increasing the overall attractiveness of the London office market. Sensitivity Analysis: The London office market will face two possible scenarios that are: The current trend of dominant foreign investment will continue and there will be more investment opportunities. There will be decrease in the overall investment and the investors will withdraw the capital and investment from the market. Different issues, their implications and associated outcomes along with their likelihood and importance (out of 5) have been listed in the table below: Issues Implications Outcomes Likelihood Importance The long term investors hold the property for longer time period as compared to the market average There will be decrease in the overall property volumes in the long run which in turn will result in market shrinkage There will be little evidence of valuation There will be decrease in the overall profitability 4 2 4 5 The properties are not listed in the IPD sample This will reduce the overall transparency of the market The overall market will not remain institutional and there will be overall worsen situation and trends The competitiveness of the overall market will decrease 4 1 5 4 Investors change the overall criteria for investment The pricing of the property is effected more by the weight of money as compared to the market and economic factors This will decrease the long term yields There will be low volatility in the market in long term There will be lack of lot size differential 1 5 4 1 5 4 The decrease in the investment and withdrawal of the funds by the international investors The overall London office market has to be adjusted This will result in returning the property companies to the core markets of Central London There will be shortage of fund for investment and development 2 3 5 5 Conclusion and Recommendations: The overall London office market is attractive for investment. Despite of certain risks and challenges there is increasing number of investments in the London office market. The market will show positive trends in the future as well. There is no such considerable risk which will result in decreasing the investment in the London office market. There is overall growth in the industry and it is being predicted that same trend will follow in the future. The company should invest in the London office market. With the global economic scenario, it is obvious that changes will continue to take place in London office investment and mix will have varied flavors from round the world; to mention few, India and china growing investment specifically from High Net Worth Individuals etc. However, the risk remains with global dynamics accepting and responding very varied factors. Greater dependency on capital inflow from abroad can affect the legal system, country stance etc. Pound sterling change against other currencies is a factor to be considered. Thus, the cost and benefit analysis is dependent on type, kind, capital, tenure, nature, flexibility of business investment from investor. List of References Ball, M., Lizieri, C., and MacGregor, B. (1998). The Economics of Commercial Property Markets. London: Routledge CBRE Research. (2012). Central London Property Market Review. Available from http://www.cbre.eu/portal/pls/portal/res_rep.show_report?report_id=1949 [Accessed 23 August 2012] EC Harris. London office development pipeline: the challenges ahead. EC Harris Built Asset Consultancy. Available from http://www.echarris.com/pdf/8199_london%20office%20PipelineFINAL.pdf [Accessed 23 August 2012] Hoesli, M., and MacGregor, B. (2000). Property Investment: Principles and Practice of Portfolio Management. London: Longman IPF. (2007). Understanding commercial property investment. Available from http://www.bpf.org.uk/en/files/reita/reita_org_documents/reita_guides_ifa_guide_May07.pdf [Accessed 22 August 2012] LaSalle, J. (2012). The implications of global capital flows on the London office market. London: City of London. Available from http://www.cityoflondon.gov.uk/business/economic-research-and-information/research-publications/Documents/research-2012/Implications%20of%20Global%20Capital%20Flows.pdf [Accessed 23 August 2012] Savills. (2012). The Challenges to London’s attractiveness to international investors. London: Savills Research. Available from http://pdf.euro.savills.co.uk/uk/commercial---other/challenges-to-london.pdf [Accessed 22 August 2012] Sayce, S., Smith, J., Cooper, R., and Venmore-Rowland, P. (2006). Real Estate Appraisal: From Value to Worth. Oxford: Blackwell Standard Life Investments. (2012). Investment Report: pooled property fund 2nd quarter 2012. Available from http://uk.standardlifeinvestments.com/CP_Sample_Property_Report/getLatest.pdf [Accessed 23 August 2012] The Guardian. (2012). London’s economy: how strong is it? Available from http://www.guardian.co.uk/uk/datablog/2012/apr/12/london-gdp-economy-data [Accessed 22 August 2012] Read More