Foreigners pile into Britain's cut-price commercial property market

Building owners slashed their prices by as much as 20 per cent during the downturn, but the interest from overseas is likely to remain strong long after the economy bounces back due to the generous tax treatment they receive. Mark Leftly investigates

Australians, Germans, Norwegians, Lebanese, Ukrainians and even Libyans are among the nationalities coveting British commercial property.

A quirk of the property downturn in the UK, which saw the greatest names in the industry report horrendous losses over the past couple of years, is that the country's estate has become an investment opportunity for overseas money. Property owners in British commercial centres, particularly London, reassessed and lowered the prices of their buildings quickly – and by as much as 20 per cent – as domestic rivals with weak balance sheets no longer chased their stock.

Property adviser CB Richard Ellis (CBRE) will publish research later this month showing that 73 per cent of commercial property purchases by value in central London last year were made by foreign investors. In the previous 10 years, only 49 per cent of investment originated overseas. The London market avoided total collapse last year because of the £5bn-plus these players were willing to spend in the big smoke.

Among the more eye-catching transactions were the National Pension Service of Korea's £772.5m acquisition of the HSBC tower in Canary Wharf and sale of the US embassy to a subsidiary of Qatar's sovereign wealth fund. Although the value of that deal has not been disclosed, it is known that the fund, Qatari Diar, has spent more than £3bn on UK property. It is aiming to spend about £2bn more on primarily British office space.

The Qataris, who also took a 24 per cent stake in Canary Wharf co-owner Songbird Estates last year, are not alone. Having got a taste for high-quality commercial real estate in the City, West End and Canary Wharf during the rough times, overseas investors are set to continue to pounce on London buildings in 2010.

The prestige

Kevin McCauley, the CBRE's head of central London research, says: "Though I don't think that level [73 per cent] is sustainable, I do think this amount of overseas investment will continue in central London for buildings worth £100m-plus. There were 15 transactions of that order in 2009 and there will be more this year."

Some overseas players might lose interest in the less valuable and prestigious schemes this year because building prices have started to come back, says McCauley. This price increase has been partly fuelled by the emergence of UK players that have raised opportunity funds.

Industry heavy-hitters Mike Hussey (see box) and Andrew Jones, who last year quit FTSE-100 giants Land Securities and British Land respectively, are among those quietly mulling bids for landmark projects.

Also, McCauley says, many banks are using the buzz phrase "extend and pretend". That is, they are ignoring breaches of certain terms on which they lent to property developers, in the hope that the market will bounce back. Banks do not want to take the keys to properties that they do not understand how to maintain and let.

"We haven't seen the level of forced selling that we expected," says McCauley, so an undersupply of stock is pushing up prices again. "Banks are willing to roll over loans provided interest rates are covered."

Colin Wilson, the head of central London investment at listed property consultant DTZ, agrees that the bigger overseas investors will continue to snap up the capital's buildings because of "underlying fundamentals". By this he means strong rental growth from blue-chip tenants and potential demand growth for office space. "Overseas investors had the wind in their sails last year, and there's no reason for them to change course," argues Wilson, who estimates that he spent up to 90 per cent of his time with overseas clients in 2009. Typically, the majority of meetings would be with UK funds.

The Cayman Islands of property

Wilson argues that the poor performance of the pound meant that UK properties represented even greater bargains for dollar and euro-denominated investors in 2008 and 2009.

For Europeans, such as the commercial property-hungry German funds and Norway's krone-denominated sovereign wealth fund, London remains a snip. But the renewed interest in the financial centres of the City and Canary Wharf does not rely on a weak pound.

Dean Hodcroft, the head of real estate and construction at big four accountant Ernst & Young, says the UK is "a tax haven" for overseas buyers. They pay a minimal amount of income tax once running costs and debt costs are factored into their calculations, stamp duty is usually reduced from 4 per cent for a domestic owner to 0.5 per cent, and capital gains tax can be avoided by setting the deal up through shares or unit trusts rather than buying the property directly.

Hodcroft estimates that a £100m building, of which 50 per cent is funded through loans, would result in a UK company paying 30 per cent more income tax than its foreign competitor. So while properties in New York, Tokyo, Paris and Munich might become more attractive as their prices fall, London will still offer plenty of financial incentives.

Chris Brett, an international desk director at property agent Jones Lang LaSalle, has acted for Malaysian funds in the UK. He says that these investors, plus funds from China, Bahrain, Abu Dhabi, Qatar and Kuwait, are still on the hunt for UK property as they look to balance the risks in their investment portfolios. "Places that are diversifying to protect their long-term wealth without having to rely on their natural resources will still demand property," he says.

Dealmakers

Importantly, given the influence they have on sourcing the very biggest deals, City rainmakers agree with the corporate finance advisers at the leading agents. Patrick Long, a director in the real estate team at investment bank Lazard, says: "The UK is the most transparent and liquid property market in Europe. We expect to see continued interest from overseas particularly in investing alongside established local players."

A prominent example of this type of joint venture is Chelsfield Partners, the property company run by industry bigwigs Sir Stuart Lipton and Elliott Bernerd. The duo's backers include the Qatar Investment Authority and Saudi Arabia's Olayan Group.

The City and Canary Wharf markets will be cheered by Long's words, as 90 per cent of all investment there last year was from overseas, according to adviser Cushman & Wakefield. "Until the general election, I can't see any reason why this level of demand should change too much," says Bill Tyser, the head of City investment at the firm. "We have good-quality product and overseas investors are getting 6 to 7 per cent returns."

As a result, that extraordinarily eclectic bunch of Eastern Europeans, Scandinavians, Antipodeans, Arabs, South-east Asians and North Africans will be spending big bucks on City landmarks for some time yet.

Moving On: Hussey sets tongues wagging with new firm

For all the overseas funds that are preparing the next property investment push, it is the UK's own Mike Hussey who has been causing tongues to wag in what is arguably the most gossipy industry of them all.

Hussey was the head of the £5bn London division of Land Securities, one of UK property's big-three listed companies, until last year.

A demerger was planned, which would have left Hussey in charge of a new, slimline player that would have still commanded a place in the FTSE 100. However, group chief executive Francis Salway decided against the move, leaving Hussey in limbo.

Hussey left to set up a vehicle expected to be worth around £500m. He teamed up with Neil Jones, an old chum who is a former European director at Grosvenor.

The duo are believed to be putting the finishing touches to the business's equity raising, with an official launch expected later this quarter. Jones, with his thick overseas contact book, will help Hussey dip into Paris.

It is understood that they will be targeting properties valued at £100m-plus.

Already Hussey has considered a bid for Morgan Stanley Real Estate's stake in Elizabeth House, a landmark building overlooking Waterloo in London. Although he had not completed his firm's capitalisation, an industry source suggests that Hussey's pulling power was enough to secure the backing of a wealthy individual.

However, Hussey decided against the move, and so is not on the shortlist of two-to-three parties drawn up by Morgan Stanley's advisers. But it does mean that Hussey's name has finally been linked with a major buy after months of fevered speculation.

And it surely does Hussey no harm that he was up against the likes of London & Regional Properties, one of the sector's big unlisted empires, which also decided against a bid.

The new company, the name of which has been kept secret, is believed to have lined up half a dozen staff for its Paris office and about 12 for London.

Hussey is back – and will surely complete a major deal soon.