Paris – pourquoi pas? Why Paris attracts less investment than London.

Speaker: Andy Schofield, Director of Research at Henderson

There was a pleasing irony that the subject for our lunch on 25th October was the comparative investment merits of London and Paris. Henry V would, of course, have attached a different meaning to the word ‘investment’ than that used by our speaker, Andy Schofield, but, as Henry was equipped with long bows, so Andy was equipped with the research power of Hendersons.

Paris, of course, is not bereft of investment sources for real estate, but, whereas London seems able to tap the world, Paris draws its money more locally, and thus from a smaller pool. Why is this? Andy reviewed the elements that seem important to trans-national investment.

Both markets are quite liquid, but recent history shows that London remains more liquid at times of stress across a wide range of lot size. London also offers this liquidity in larger lot sizes. Both markets are in the Jones Land la Salle top 10 for transparency, but Andy argued that London valuers appear to be more aggressive and realistic in responding to market changes, which adds to confidence. On past performance there are, of course, differences, but Andy doubts whether that is a dominant factor in investment decisions. On all these criteria, then, there appears to be not much material variance. What tips the balance?

Andy picked two facts. The first is the London lease structure. Lease lengths of 10 years plus, with upward only rent reviews is attractive when compared with Paris’s 9 years with a break at 6 and an indexed review – i.e. perhaps an improved chance of a rent rise, but, of more significance, also a chance of a fall. The London structure is greatly to be preferred if borrowing is to be part of the transaction. There is no evidence that Paris occupiers are actually more footloose, but the security is a key factor.

The second key factor in London’s favour is its international status, particularly in finance. Some would argue that it is top, whereas Paris is 22nd. This brings familiarity amongst key decision-makers, and a sense of ‘bottom’. If you are a serious player, London is a ‘must’. Paris offers, of course, many jewels, but London has the Crown Jewels. (Your Scribe’s fantasy!)

In the subsequent discussion, London’s enduring eminence was questioned. Will the disgrace of financial markets devalue the merits of being a financial centre, and allow the centre of gravity to move away? Whilst this was thought to be a factor, a number of contributors pointed to the blossoming of other ‘international’ markets in London – business services and creative industries, for example; perhaps it will not need to depend so much on finance. The problems of the Eurozone, Andy felt, whilst very real, will not much affect comparisons between the two markets; Europe as a whole will swim or sink. Finally, current taxation proposals in France seem to be potentially damaging; as your Scribe’s addition, one thing the French are pretty good at is realism, once the gesture is got out of the way.

Andy was therefore pleasingly upbeat about London. However, there are storm clouds over Europe; its No 1 status may soon join Agincourt as a glorious thing that was not, perhaps, quite as glorious as myth paints it.

Michael Mallinson

What Makes a Rent? A Look Across Global Cities

Speaker: Maurizio Grilli, Group Senior Research Analyst, Grosvenor,  (www.grosvenor.com

After our Lunch on 28th June, your Scribe went to Covent Garden to hear ‘Les Troyens’, the epic opera about the mission of Aeneas to found Rome. I don’t know whether Maurizio will encounter a Dido on the way, and certainly, working for Grosvenor Estates he is not fleeing a burning City. Nevertheless, the task he described for us seems to have similar epic qualities: he is seeking to create a model that will explain the incidence of high rents in offices. Maurizio emphasised that, working for a landowner with long horizons, he is not concerned with what may be seen as volatile ‘noise’, but with the fundamentals of value creation. His ambition is that the model must have global application; I don’t think he mentioned Antarctica, but otherwise truly global – perhaps 500+ cities.

Currently, he is working on four variables which he hopes will be able to explain 60 to 70% of observed long term variation, i.e. variation with the ‘noise’ removed. His variables comprise GDP, Quality of Life, Connectivity and Demand/Supply.

GDP epitomises underlying economic activity; for this he can rely upon hard and extensive data. Quality of Life is more subjective, but is intended to capture the background of personal wellbeing that encourages the development of office-based service industries and capacity. He presently uses Economist Intelligence Unit data. By Connectivity, he is seeking to capture the critical mass of commercial activity, which will, of course, encompass electronic, travel and other forms of business inter-connection. He uses a count of global company HQs as his proxy, and finds this to provide one of the strongest variables. Finally, Demand/Supply. This is likely to be the strongest factor in the background noise, but he tries to see through that by viewing vacancy rates over 20 years. What he is seeking is evidence of long term supply constraint against a background of inherent high demand.

In subsequent discussion, Maurizio conceded that his four variables may not capture all that is required, agreeing, for example, that there are issues about legal security and a low incidence of corruption. As a subsequent thought, are there issues connected with educational standards? But maybe these are captured by ‘Connectivity’. He also agreed that, whilst he was only addressing office rents, a similar approach could well be valuable in other markets.

Maurizio was a convincing advocate of his approach, and there can be little doubt that such model-building should bring valuable insights. Your stick-in-the mud Scribe does wonder whether his clients will have the courage to follow the results he achieves if they stray too far from intuitive prejudice. After all, so-called research in other markets has had poor results for most investors. But it seems clear that Maurizio’s work will be an aid to clarity in what is likely to be a more complex world.

Michael Mallinson

Going for growth – the role of the 21st century Garden City movement

Charlie Hughes is a man with a mission, and, with great charm, he gave us both barrels at our lunch on17th May. Charlie is Chairman of Smart Futures and Chairman of the European Urban Regeneration Council at ULI.

Ebenezer Howard was a visionary in the development of town planning with his 20th century penchant for ‘Garden Cities;’ from that grew, perhaps in a distorted way, the British New Town movement. That has now run its course, but Charlie argues that as we are not meeting, and cannot hope to meet, our housing needs by ‘conventional’ means, it is time to re-visit and reinvent the Garden City as a socially-acceptable form for extensive development. Such thinking now appears to have a fair political wind.

Despite his missionary tendency, Charlie is clearly pragmatic about how the trick might be brought off in a world of planning authorities and ‘NIMBYs’. Your Scribe drew out seven principles from what he said.

First of all, any proposal must start from a financial framework, not a planning one. The resulting ‘City’ must, of course, manifest town planning of the highest order, but financial imperatives must rule, not planning visions. This led to an uncomfortable truth that successful projects are likely to lie in the NIMBY-rich South-East, not the more welcoming, but cash-strapped North. The financial framework will require sophisticated engineering, realistically apportioning risk to the needs of those providing the various tranches of finance. Early risk would probably have to lie with the public sector, later risk with the private sector.

Secondly, the proposal must secure cross-party support so that its delivery is politically secure over an extended period; the New Towns showed that this can be achieved. It would also be necessary to secure local business and private support; although nimbies are vocal, they are not always the majority.

Thirdly, the delivery ‘authority’ must be given the powers to deliver, without being subjected to whinging pressure groups; once the political decision is taken to build, it is built. This was, of course, the great strength of the New Town Development Corporations.

Fourthly, the delivery authority must not be politically-driven, but project-driven.

Fifthly, the financial structure of the project must be such that much of the land value created is captured and re-cycled to enhance the development and subsequent management of the City. No doubt this will require a small modicum of profit-sharing with landowners, but the principle of value-capture is important.

Sixthly, the planning and design must deliver not only excellence, but also variety in tenure, variety in price, and variety in size and quality; this principle of variety should apply to the commercial as well as the residential elements.  

Seventhly, the development framework needs to provide for long-term ‘community management’, particularly, but not exclusively of extensive ‘communal areas,’ areas that are indeed managed, via trustees, by the community with secure ongoing funding. (Did I hear praise for Milton Keynes in this?)

Despite this clear vision, Charlie was well aware of the difficulties. Providing the central drive runs counter to ‘localism’. Political and planning lobbies are strong; if a local authority takes an initiative, will it be willing to let go? The UK has a poor record in private/public co-operation. There are legal framework challenges, not least in overcoming the Leasehold Reform Act. Above all, there is the challenge of generating a critical mass of support.

My father warned me against men with visions – but he hadn’t met the persuasive Charlie.

Michael Mallinson

Post script

The government will be inviting proposals for the development of new Garden Cities from July this year. The publication ‘creating garden cities and suburbs today’ can be found on www.tcpa.org.

Spanish Real Estate Crisis: A Perspective from the Inside

José María Sanchez de la Peña was a man with a problem when he came to address our Lunch on 15th March 2012. It was a lovely early Spring day, with Hyde Park looking full of promise, but his message did not match this backdrop – by some distance. Apart from a few favoured locations in Madrid and Barcelona, all parts of the Spanish market are in retreat. Despite falling by around 30%, housing is still not affordable, and, with a weakening economy, demand from business occupiers remains feeble. Banks have become effective owners of large swathes of property, but have really not yet ‘bitten the bullet’ of changed circumstances. There are many examples of their selling buildings with 100% mortgages; the triumph of hope over reality! With very few exceptions, whilst land might have a price attached to it, it has no value. In response to a question, to emphasise the darkness of his message, José María doubted whether this represented a good ‘buying’ opportunity.

To make his message bleaker, the prospects for recovery seemed remote. He saw values falling for a further 12 or 18 months. Beyond that, the future was not really in Spanish control. If the Euro and Europe could be stabilised, then a base from which growth could start would be found, but bringing about that (relatively) happy state was not in Spain’s gift; the big issues lay elsewhere. Whilst José María emphasised that he did not want to make political points, the recent change of Government had, perhaps, removed one of the sources of trouble, but it was far from clear that the new lot could find the way out.

This description of such a dark picture left your scribe wondering how Spanish Society was coping with it; José María drew attention to the foundation of National Socialism in Germany in dire economic circumstances. However, there are two counteracting forces. First, there is a very extensive ‘black economy’ – ‘black’ in the sense of being below the radar of official statistics rather than illegal. The second is the strength of the ‘family’ in Spanish tradition; most people live in a supportive social context that mitigates, and spreads out misfortune.

I found José María’s words academically interesting (an insight into how it feels when economic distress reaches a tipping point), but socially deeply disturbing. I felt there to be a degree of desperation in that there seems to be no view of an exit from the present turmoil. The message was a gloomy one, and your Scribe may have over-emphasised its blackness; José María was clear that there are opportunities; you just need clear eyes and brain to judge them. However, in response to another question, he did not seem to think that there was a deal to be done in that Spain has a million houses to spare and Britain has a million people wanting homes.

Michael Mallinson

Stagflation becomes stagnation; buy property not peanuts in 2012

Overview

Our speaker at the lunch on 19th January was Prof. Angus McIntosh, Economic & Sustainable Property Consultant with Real Estate Forecasting Ltd and Oxford Brookes University. Prof. McIntosh gave us a passionate and persuasive case that prime UK commercial property investment will have the best decade in real terms of performance (apart from the 1990s) since the 1960s. Total returns will out-perform inflation. To find out why and how please read on below.

Members and guests were persuaded so during the Q&A session most discussion focused on where value could be found in the markets both sector and location. The risks inherent in an uncoordinated green agenda were also explored fully.

Economy

As inflation slows down from over 4.5% to 2.2%, and economic growth falls from 0.9% to only 0.4% pa or less in 2012, stagflation (higher inflation but lower growth) has receded. Economic stagnation is with us, but this is not as bad for property investment as conventional wisdom dictates.

Even if the Euro currency does not collapse in 2012 (this is still less likely – Germany has far less to lose by holding it together) UK economic growth will be close to a double dip recession. At present all the Euro policies are wrong; extreme austerity (as imposes on Greece & others) never worked in South America in the 1960s, nor in Russia in the 1990s, nor even in Germany in the 1920s. You would think Europe knows the consequences can be disastrous.

Quantitative easing, a low bank rate and a low value of £Sterling will assist the UK economy.

Commercial Property Rents

London office rents remain the only star in a stormy sky; across much of the UK office rents will fall further.

The credit crunch has now become a consumer crunch; down-town retailing will collapse still further. All out-of-town retail property will out-perform in-town property rents. Even the London Olympic Games will not change consumer sentiment; London is already performing better. The rest of the UK will remain a tough environment for many retailers.

Industrial rents will mark time; what you see is what you get, for at least three years – despite the on-going explosion of on-line retailing, which is further undermining down-town retailing.

Residential Property

House prices, apart from Central London (where funny money from around the world is "parking funds" in the market) will stagnate for at least five years.

Residential investments to lease, especially in South East England, will produce returns (mostly income) of three times the rate of inflation, at +7% over the next 5 years.

The Green Agenda

The "Greenest Government Ever" has lost its way; short-term political expediency from 11 Downing Street will eventually cost the UK far more than, for instance, the financial legacy debacle of defunct PFI projects dreamt up over 10 years ago.

The legal farce the Government created, by dramatically lowering the feed-in-tariff for homes making photo-voltaic energy, two weeks before the consultation period ended, is symptomatic of the mess.

Climate change is a reality – however caused. Over the medium term oil, food and all commodity prices will rise faster then general inflation, caused by crop failures (sure as peanuts in 2011) and the Asian economic boom. The UK needs to both save energy and make far more green energy to protect its future.

The Green Deal (enshrined in the Energy Act 2011 allowing energy companies to retro-fit buildings) is unworkable and very expensive to operate. It is lacking due-diligence and enforceability. It is a sop to voters, and unlikely to work in the commercial property market.

Energy Performance Certificates are an un-regulated unenforceable expensive farce; 4 un-regulated assessors could legitimately produce 4 different certificates. The BPF and many others have campaigned for compulsory Display Energy Certificates on all commercial buildings. This would wake up the property market to their energy profligacy, and accelerate the UK’s declared commitment to meeting lower energy emission targets much sooner.

However, the taxation on energy (the largest in the world) via the Carbon Reduction Commitment will make the negative impact of climate change even worse. It is a regressive tax and does not address the need for a progressive tax based on both the whole-life carbon emissions of buildings and its market value. As proposed lower valued buildings will proportionally pay far more CRC tax than valuable investments.

For investors, the main worry is that the cost of the Green Agenda (Building Regulations are becoming ever more expensive) is eroding asset values dramatically. There will be winners and some dramatic losers.

Retrofitting or rebuilding buildings, which are, say 20 or 30 years old, is becoming increasingly expensive. For example, any office with less than 5 years lease un-expired, in a market where the PRIME rent is less than £20 per sq ft, sits on a negative land value!

Investment

Property not peanuts; world peanut prices have exploded by between 60% and 100% in 2011. Go short in peanuts in 2012, but long on well-let commercial property.

With average investment income yields at 6% pa, and with general inflation expected to be below 2.5% for the next 5 years, a real return of over 3% looks very attractive. Buy whilst stocks last!

Commercial property investment will have the best decade in real terms of performance (apart from the 1990s) since the 1960s. Total returns will out-perform inflation.

It is hard to see gilts repeating the performance of the 1990s, with yields starting from such low levels. Yields would have to fall even further to even achieve a 2.5% real return. More likely gilts will struggle to achieve a positive real return at all, leaving property looking like a valuable asset class in a diversified portfolio.

These are conditions are not normally thought to favour property returns, but low inflation has typically been good for real property returns, as inflation is not fully passed on into rents, and therefore nominal returns remain relatively high.

But be beware; for older stock, in poor locations, investment asset depreciation (especially for non-green buildings) is widespread.

UK -- The Big Chill

At the final lunch of 2011 we were treated to an insightful, if at times dispassionate, talk on the economic prospects for the UK by one of the foremost economic commentators of our times: Bronwyn Curtis, OBE - Head of HSBC Global Research.

Earlier in 2011 Bronwyn had spoken about the prospects of "a lost decade" which the eminent Martin Wolfe of the FT also has used in his economic commentaries.

The UK already has had 12 quarters of recession along with anaemic growth leading to the economy "bumping along the bottom". The last 7 recessions experienced by the USA had all been 5 quarters. With very low growth, GDP is still 4% below the 2007 peak in the UK, slightly ahead of the USA which is 5% below their peak and Europe at 6.2% below its peak. The recession developed as a result of debt in the private sector which now has moved to being a public sector debt problem.

Our speaker took us through a wide range of negative economic indicators for the developed world, including the more recent downgrades of anticipated growth from 2.3% pa to 1.4% pa. In contrast, growth forecasts for the emerging markets had slipped from 6.2% pa to 5.9% pa.

Why are these indicators so awful? This is a combination of: policy makers having to issue cheap paper whilst remaining highly leveraged; oil prices staying up as a result of emerging market growth leading to even greater tax on consumers and the fact that 50-60% of the UK’s and USA’s economies being consumer driven with 9-10% being unemployed. The UK can expect a further loss of 300,000-700,000 jobs in the public sector which will have been cut by 16% in real terms by 2016.

The conclusion Bronwyn offered us fitted the billing. We in the UK should grow old gracefully and accept we will be worse off, or, emigrate. Brett, like the speaker, an Australian ex pat, asked should we move to their home country. The response was we should learn Mandarin.

As some pulled their Christmas crackers during a lively Q&A on the prospects and implications of Europe consolidating or breaking up in part or whole (very hard to do and massively disruptive) others could not get in a festive mood. Given there appears to be a 50/50 prospect of 17 European countries having their credit ratings reduced within 90 days, 2012 is likely to offer little cheer. It was encouraging to hear our Spanish colleagues stressing the importance of strong links and economic ties with the UK for their country.

London Chapter treasurer John Dallimore, who persuaded Bronwyn to speak, made the observation in his opening remarks that perhaps the talk was 2 or 3 days early. How observant given the Cameron veto over the following weekend. We now wonder what will unfold in UK and Europe in the next 90 days and decade beyond. Where is growth to be found beyond China and the emerging markets? Answers, thoughts and observations welcome . . .

Mark Loveday
December 2011