Everything must go

In the recent months, caution has been the name of the game in the property market. Investors have held back from putting their money down for fear of loss as analysts – known as ‘doomsayers’ before the credit crunch – warn of a ‘double-dip’ recession. Meanwhile, potential leaseholders have been waiting, guessing and gambling on just how low rents will go before making their move.

It could now be the time for everyone to put their cards on the table. As an increasing number of foreign investors move in to snap up a decreasing pool of Grade A property in London, British-based companies and investors are realising that if they want to make a move into, up-size or increase holdings in London, then the time to act is now.

This is not to say that conditions are necessarily improving. Instead, their hands have been forced by international investment groups, who have been circling the market ready to move. Groups like Goldman Sachs for example, with a potential $6.3bn to pump into real estate investment worldwide, will see the UK as an appetising prospect, especially when some London properties have reduced in price by up to 50 percent.

The chances are that action of such groups will be swift.  And if UK businesses want a slice of this action then they need to make a move now.

Significant deals have already occurred. The most high profile is most certainly Songbird’s significant share buy-in at Canary Wharf, where it has invested £625m to take a near 70 percent stake holding in the development. Meanwhile, Nomura’s significant rental of 541,000 sq ft at Watermark Place at £40.50 per sq ft also represents an important deal in terms of London office rental.

There is currently a near daily trade of high quality buildings occurring. Kajima Properties’ purchase of 103 Mount Street in London’s Mayfair from Prupim for just over £31.5m and Munich-based KGAL’s £30m purchase of 30 Park Street in London Bridge are just two examples to suggest that foreign companies are seeing London as the place to buy.

Reports suggest that some large-name companies within the UK are already making a move. CB Richard Ellis has suggested that retailer Debenhams is looking to source a new HQ to replace that behind the one behind their flagship store on Oxford Street. Meanwhile, oil giant Shell is reportedly seeking a temporary space to site some of its employees while part of its own HQ, The Shell Building, is renovated. With these big players mobilising, the push to scoop-up top space in London is definitely on.

Yet such deals represent only a superficial sign of recovery in the market. Though prime property is disappearing (not all in particularly strong deals), the bulk of lower grade, cheaper units that make up the vast proportion of the market remain unsold or vacant.

As the recovery from recession reveals it is likely to be almost as bad as the recession itself for the foreseeable future, owners are increasingly feeling the pressure. So far owners have done their best to fill their rental properties any way they can. Yet there are only so many rent-free periods that landlords can afford to agree to. In the last issue of Estates Review, we reported on the chief executive of Minerva, Salmaan Hasan, who said that deals involving large numbers of rent-free months occupancy (like Nomura’s deal, believed to include up to four years of rent-free periods) would soon be at an end. He will likely be proved right.

Arguably this is because landlords, who have been bent over backwards for a long time trying to fill property, are now reviewing their options – including ways out of the commercial market altogether.

This is largely due to the change to empty rates relief in 2008, which has effectively doubled rates paid on empty buildings with ratable value over £15,000. This has had a considerable impact on the out-goings of owners in the commercial rental market in London. Its a situation the Government is likely to make worse with its plans to remove the benchmark £15,000 value in the spring of this year – effectively harming more commercial owners. In such cruel economic circumstances, it is no wonder that owners are considering increasingly extreme measures to escape expensive property.

One option is demolition. Though a drastic measure, there is business sense behind the idea. With the rarity of vacant land within London, the opportunity to demolish and then sell off land is more attractive than holding expensive empty Grade B commercial property. And as chief executive of Land Securities, Francis Salway, points out about the current economic situation: “Development is more attractive than straightforward investment now.” Even if the land is not sold for development straight away, it is still cheaper than a vacant building.

This is a risky strategy, as other top names in the industry have shown their reluctance to build property in these economic conditions. John Burns, chief executive of Derwent London, has outlined that they won’t build simply for the sake of it: “We are not going to press the button if we will go into negative territory.” This varied attitude of some construction companies being ready to develop while others are not makes demolition a gamble many in the market will not want to make, especially if the market continues to be slow.

A more appealing prospect that could dent the amount of spare commercial property is the prospect of schemes such as commercial to residential property conversion. This is an idea that has seen buildings, such as old schools or offices, utilised as temporary or permanent rental property, or converted to flats.

While most commercial property owners will balk at the idea of becoming a residential property owner, with the prospective costs of conversion and maintenance, there are perks to the idea. The obvious is that once the relevant paperwork is filed, the building will not be liable for pricey business rates. Equally, in London the demand for residential space has far from subsided during the recession.

The residential rental market has also not seen the significant falls the commercial property market has seen, predominantly due to the size of the spaces involved (as the rent on a one bedroom flat is far less negotiable than on 50,000 sq ft of commercial space). And if the sale of individual flats is planned after conversion, then the current housing market in London is in a better position currently than the commercial market. Even if there is not a total take-up of a commercial-to-residential scheme (in terms of rental or sale), partial rent or sale is still preferable to simply losing money in the current situation.

Even if neither of these options becomes particularly widespread, London owners will likely find other ways to dispose of their currently less desirable property. Combined with the swift take-up of London’s prime property, the property market candle will really be burning at both ends.

As perverse as the current inequality is between desirable and unwanted commercial properties, space in London is disappearing fast. Regardless of whether a deal is for prime property or for a lower grade, for those who can not bear to miss out on the ‘deal of a generation’ in the capital, time is most certainly running out.