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Propcos e-briefing: Inward Investment to London Real Estate – why is it happening and with what impact

    • Real estate sector


    For international real estate investors, London and the UK are separate countries. London belongs to “Globalopolis”: an elite group of global mega-cities, transcending their homelands in economic importance. Since 2008, London has attracted over £40 billion of overseas real estate investment; whilst the wider UK property market has languished. This has led to some misplaced and arrogant ideas. London, some say, is a first rate city trapped in a second rate country, and its massive real estate investment inflows are seen as the new (and long term) “normal”.

    But London is not uniquely or eternally attractive to investors. Of course, it has much to recommend it: liveability, easy access to global markets, a concentration of global HQs and high quality buildings, an extremely liquid market and a strong, improving infrastructure. These factors ensure that overseas investors chose London, rather than other UK cities. But they are not the reasons for the scale of the flows.

    Those reasons are located not in London, but in the countries where the money is born. The middle and far eastern sovereign wealth funds are holding almost unimaginably vast surpluses. Equally, the recovering US economy has given US vulture and private equity funds renewed animal spirits, and firepower. In a world where bonds are too low and equities too unpredictable, the managers of this money need to find yield and diversification. Property is one answer to their problem.

    London property is a particularly attractive part of that answer. Sterling’s weakness means a profit on entry. Pricing is still below the 2005/6 peak. UK interest rates are at a 320 year low. UK law allows structures which hugely reduce capital and income taxes. Within this framework, a relatively modest (for a sovereign wealth fund) capital allocation will secure a grade A building with a blue chip tenant. This provides steady income in unstable times, a reasonable hedge against inflation and a useful diversification: performing better than bonds, more stable than equities.

    London’s inward investment mini-boom is more about comparative international markets, the wider investment universe and the global imbalance in surpluses, than it is about London’s attractiveness or the quality of its real estate per se (strong though both are). So if these wider investment facts change, then (Keyneslike) inward investors may change their minds about London.

    London went through a similar cycle in the late 1980s. Between 1988 and 1990, the Swedes and Japanese poured £2.3 billion and £3.2 billion respectively into UK property – 80% of it into London. Then the government raised interest rates to counter inflation. Between the end of 1989 and 1992, central London’s capital value index halved. The Swedes and Japanese sold up and went home.

    There are similar downside risks this time. Inflationary pressure means interest rates may rise; bond and equity markets may move to real estate’s disadvantage, the government may over tax or excessively regulate the market and the IMF’s UK growth fears may prove correct. Ultimately, the real estate markets track the wider economy.

    There is an urban myth that once inward investors buy London property, they never sell it - so forcing up prices and shrinking the market. That may be true in certain niche west end sectors; but it is not true for most inward investors. Market history shows the majority (like the 1980s Swedes and the Japanese) will, if the market dictates, sell and leave London. Whilst there is some trophy hunting, it is lazy stereotyping to over- emphasise it. Inward investors, like everyone else, are driven by currents in the world economy.

    Given that London’s inward investment boom won’t last forever, how is our industry and government reacting (and how should they react)? The government should resist the temptation to increase real estate transaction taxes any further. It should also strive to keep market regulation to the minimum necessary. We can’t control global market movement, but we can (and should) control tax and regulation to create the optimum inward investment environment.

    This is particularly important because these inward investors are stimulating a wider property market recovery. Priced out of their capital city, UK investors and institutions are turning to alternative assets and regions. Seven per cent for a blue chip Nottingham corporate HQ, against sub five in London, makes an eloquent case for regional investment. Prices are beginning to rise in Manchester, Birmingham and elsewhere, as investors look for non-London prime offices, logistics, and regionally dominant shopping centres. Deeper than this, Bill Hughes, LGP’s innovative MD, is advocating “good secondary” which can be refurbished or tenant engineered back to prime.

    UK institutions are also moving into sub-sectors offering strong long term characteristics and stable income, but without London’s pricing pressure: the private residential sector, student housing, and infrastructure and energy assets. Indirectly, London’s inward investment boom is driving a regional real estate recovery, encouraging innovation by UK investors, and helping the performance of Land Securities and British Land as they create world class central London product.

    No one should be complacent. The government’s tax and regulatory regime, and infrastructure investment, must better the global competition. Our industry must create sufficient grade A assets to satisfy investor demand. Only by viewing London in global context, and competing in the endlessly repeated “X Factor” for gateway cities, will we keep attracting investors to London and maintain its world status.