Going for gold

When news of Britain’s successful bid for the 2012 Olympics was received it only took minutes before the residential property boom started and speculative private investors began piling money into apartments that sprang up in its wake.

As we are now only 18 months away from the start of the London Olympics do opportunities still exist, especially in the commercial market? After all, the site is only eight miles away from Westminster, and half that from the Docklands. With the improvement in transport links and the Olympian legacy of all the facilities that are being introduced it looks like a “no-brainer” for any investor.

Residential developments which are completed appear to be fully occupied, and values have not fallen as fast as many other locations; in fact, property prices in the East of London have risen 26 percent since the announcement of London hosting the games, with some boroughs seeing rises of up to 69 percent. It would seem that pioneer residential investors have indeed had an Olympian dividend and lenders fingers are left unburnt.

So, is there also a commercial property windfall still to be had or is commercial property still the pariah of the investment world? There are of course striking contrasts between commercial and residential property to take into account. The latter relates to where people live, while the former provides the space in which they work. While demand for living space does not contract if an economy shrinks, the amount of working space required for companies certainly does.

When considering the Olympics, we now also need to consider London’s new East End Tech City as announced by David Cameron in early November 2010. Like the Olympics it all sounds grand and it even comes with the backing of tech giants such as: Google, Intel and Facebook. But the question is can you ‘create’ a “Silicon Valley” outside of California?

From a commercial, and even residential, property perspective my experience says that it is very difficult to ‘create’ a district, even if the Government or Development Agencies throw incentives at developers or employers to move to the area, and thus far none have been announced.

If you look at the dynamics of the creative industry, two areas stand out in London: Old Street nicknamed Silicon Roundabout and Soho in central London. The reasons for this are obvious; firstly, tech start-ups tend to cluster around each other (as do many other types of start-ups) and secondly, and probably more importantly, cost – which is why many start-ups share office space.

From a lending and developer perspective this market is fantastic if you happen to bankroll the next Google, but the reality is that this is unlikely to happen and catering for the SME market is best left to the serviced office providers.

Back to the bigger picture, it is said that the British economy has permanently lost around five percent of its 2007 commercial capacity requirements. As a consequence commercial property values fell by around 40 percent between 2007 and 2009. Since then, commercial property has seen a fairly solid recovery with 15 consecutive months of positive capital growth. According to the IPD, as of October 2010, the compounded upturn in values stood at 15.9 percent since the recovery started in August 2009, while the 12-month capital growth rate now stands at 12.2 percent.

With such a sharp decline and modest, but respectable recovery, I would suggest that comparing Olympic residential property in 2006 with Olympic commercial property in 2010 is somewhat complicated to say the least.

For lenders or investors desperate to get in on the act, perhaps the most obvious opportunity would be the Westfield Stratford City complex and surrounding development which forms part of the £6bn investment that currently comprises Europe’s biggest construction site. This will provide around 3m sq ft of retail and leisure space, another 6.5m of office space, and over 1.25m sq ft of hotel accommodation. This has all the scale of a major commercial property project, a 50 percent stake of which has already been sold in the retail component of the Stratford City development.

Here, once again, one needs to contrast the features of a commercial property investment with those of a residential acquisition. Residential property is let on short leases to produce a moderate level of income, but with the main focus being on capital appreciation, which can only be fully realised when the property is vacant. Occupied (let) residential property is less valuable than empty.

By contrast, commercial property can offer a higher yield in the region of six-eight percent pa as opposed to perhaps four percent net of costs in the case of residential. Commercial property’s value is related to how long and secure that income is perceived to be, and if the property is vacant then that will penalise its capital value.

Taking these considerations into account with the Westfield Stratford City, a commercial property investor would perceive strong demand for his space in the build up and duration of the games, but what happens afterwards?

There are some sobering examples of the fate of Olympic facilities. The Greek example is pure tragedy. Virtually all of the 36 purpose-built venues now languish empty and unused. The main Olympic complex is actually closed to the public, while the Glatsi in-door arena is covered in broken glass and the £9bn Helliniko complex is virtually derelict.

However, not all Olympic experiences are so bad. The Spanish were far more organised in the case of the 1994 Barcelona games and their Olympic facilities are fully integrated with the city. Glasgow has taken a similar approach in their preparations for the 2014 Commonwealth Games with legacy plans in place – the athlete’s village for 6500 people, for example, will become a 1400 home community after the games.

There is no reason to believe that the UK has not been as equally thorough in its planning as the Spanish were.

However, there remains a scenario of a lacklustre economy or “feel bad” recovery perhaps extending to 2012 and beyond. If that were the case then the question must be asked why strong demand could be engineered for space in this particular vicinity unless it is created by heavy discounts compared to rental values elsewhere.

However, taking a step away from a specific Olympian context there are a number of reasons why investors are, and therefore lenders possibly should now be seriously considering commercial property once more. Reasons why, include:
- With commercial property values off 40 percent since 2007 they now offer much higher income yields of up to eight percent.
- That eight percent income may compare to the total cost of debt of five percent. This “borrowing gap” may inflate the “geared” level of income to circa 10 percent pa.
- There are signs that effects of waning demand for space and falling rents may be coming to an end, in which case tenant demand will gradually recover and with it rental levels i.e. now may be the time to enter the market. Even lacklustre growth is growth by comparison to contraction.
- Commercial property values remain well off their 2007 “highs” whereas equities and bonds have already recovered their losses.

So the timing of commercial property lending for investment may well be right. But, with the proviso you are confident that there is the demand to keep that space occupied.  This is something the Olympic facilities simply cannot satisfy in my opinion. The exceptional nature of the demand for this space in the period leading up to 2012 prevents a “normal” commercial property market becoming established.

The knowledge that this “un-natural demand” will evaporate in Autumn 2012, will leave most commercial property investors feeling queasy and similarly doesn’t make for a great lending decision, unless a three percent pa economic recovery resumes in the meantime, and that would be worth an infinite number of gold medals. Therefore, it is probably better to keep the Olympic hat on for the festivities and not allow it to influence the lending head.