Property: central London is losing its lustre

In the wake of the financial crisis, London office properties proved a popular play among real estate investors. Three years on, though, the appeal of property in the UK’s capital is beginning to wane, with some of the largest investors in the market choosing to hunt for gems elsewhere.

Standard Life Investments (SLI) fund manager Jason Baggaley believes that, after a strong run, too much capital growth has been priced into prime central London sites. Baggaley, who runs SLI’s £91 million Property Income trust, took profits in December from a key East London holding that he had bought in 2009.

At the time of the purchase, London looked as though it would lead the recovery in real estate as investors chased safe stores of income in top-end locations. To capitalise on this trend, the manager bought the Northern & Shell Tower in the Docklands area of London for £10 million. He sold the property in December 2011 for £12.2 million.

Baggaley, who runs the trust alongside SLI’s investment companies head Gordon Humphries, believes that investing in short leases, which account for more than half of all leases invested in by the trust, now represents a more lucrative opportunity than the richly priced central London market. He argues that in a low-growth environment, tenants able to maintain their business are unlikely to move, owing to the huge cost of and hassle of relocating.

‘If you look at take up and demand, it’s not great,’ Baggaley said of London’s market. ‘There is a huge yield margin, of 200-250 basis points, on short leases.’

No lone voice

The SLI team is not a lone voice talking of the dangers of buying costly London real estate. While the capital is among the most active commercial property markets in Europe, its high prices are increasingly a turn-off for investors.

In an analysis of the Continental market conducted by PriceWaterhouseCoopers (PwC), London was ranked in tenth position out of 27 rival cities in terms of its new investment and performance of existing properties in the eyes of brokers, investors and money managers. In the previous year’s survey, London was ranked in first position.

Central London office space has been one of the biggest draws of foreign and commercial investment to the capital. Last year, the sector accounted for close to a third of all real estate transactions, with an estimated £10.2 billion flooding in. More broadly, during 2009 and 2010 London was the most popular real estate market in the world. But a PwC report conducted at the beginning of the year for the Urban Land Institute suggests investors are starting to notice ‘bubble-like pricing’, while few assets were being considered a sure bet by investors.

According to SLI’s Baggaley, chasing shorter yields minimises risk, as it allows investors to focus on lease length much more than location. It also means one of the biggest threats shaping the current investment landscape – fears of a renewed recession – can be turned to his advantage.

Baggaley explained: ‘The big risk at the moment is economic growth. But if there’s not any growth, why would tenants move because of the cost of funding this if their particular business is okay? For us, this means the big risk of the moment is actually a positive, and in our current portfolio, 78% of the income at risk [due to expire] this year and in 2013 has been secured.’