London developers are adding the equivalent of 160 trading floors of office space in the main financial district in the next two years. Their timing couldn't be worse.
Prices for offices in the City of London have plunged 25 per cent since last August, the biggest drop since 1992, according to Investment Property Databank Ltd, and rents are declining for the first time in four years, said CB Richard Ellis Group Inc, which estimates rents may drop by a quarter by the end of next year.
The commercial property market won't recover until at least 2013, said Mike Prew, a real estate analyst at Lehman Brothers International Europe in London.
UK property stocks have fallen by more than half since Britain introduced real estate investment trusts in January 2007. The shares may fall by another 23 per cent by the end of 2009 as building values decline and the country slides into a recession, said Morgan Stanley analyst Martin Allen. He has the lowest price target of any analyst covering British Land Co, the biggest landlord and developer in the City.
“We don't have a supply problem, we have a demand problem,” said Patrick Sumner, head of real estate securities at Henderson Global Investors in London, which owns 1 billion pounds of property stocks. “Tenants are not going to take big decisions until things are clearer than they are now.”
Big Blocks of Space: Developers are adding about 4.2 million square feet (390,000 square meters) this year, the biggest block of new space since 1991 when almost six million square feet was built, just as the credit crisis roils financial firms and the economy.
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More than 20,000 workers may be fired in the City and Canary Wharf in the next three years, according to Prew. Firms have reported losses and writedowns of more than $500 billion from the collapse of the US sub-prime home loan market.
This year's total is more than the 4 million square feet due in 2009 and 2010 combined, according to CB Richard Ellis and Jones Lang LaSalle Inc., the world's second-largest commercial real estate broker. Developers have yet to sign up tenants for most of the new space.
Traders typically occupy about 100 square feet of space each, while other workers in the City take up about 150 square feet each. There were just 330,000 square feet, the equivalent of about six trading floors, of Grade A space available for immediate occupancy on March 31.
By 2010, the equivalent of another 120 trading floors for which tenants have yet to be found will have been completed, according to London-based realtor Drivers Jonas.
‘Cheesegrater’ Delayed: The real estate shakeout is the worst for London since the commercial property recession of 1990 to 1992, when builder Paul Reichmann lost his fortune as creditors took control of Canary Wharf.
Confidence is being shaken as developers delay or abandon projects and sellers get offers below their expectations, said Prew.
This month alone has seen two projects falter. British Land said on Aug. 14 it may postpone construction of the 600,000 square feet Richard Rogers-designed office building on Leadenhall Street, known as the Cheesegrater, so that it won't open until 2012 or later. JPMorgan Chase & Co also abandoned plans for a 1.5 million-square-foot office tower in the City and will build a new European headquarters in Canary Wharf.
Hammerson PLC agreed to sell the Moorhouse office building on Moorgate for about £250 million. That was about 15 per cent below the expected sale price, according to Property Week magazine. Hammerson spokesman Chris Smith declined to comment.
Taking a Pause: Land Securities Group Plc, the UK’s largest real estate company by market value and also a landlord in the City, said May 14 it may delay the Walkie Talkie tower, which also was due to be finished in 2011, until it can find a tenant.
“If we think a pause is the right thing, then we will do it,” said Land Securities Chief Executive Officer Francis Salway.
Leasing in the three months ended June 30 was 40 per cent below the 10-year quarterly average of 1.2 million square feet, according to Los Angeles-based CB Richard Ellis, the world's largest commercial realtor.
“There is a big overbuild — the rough numbers are about 5.5 million square feet over the past 18 months — which is bringing prices down,” Prew said. Effective rents have been cut 25 per cent so far as City landlords give as much as 30 months of free rent on a 10-year lease, he said.
Wharf Competition: A property recession will hit the City of London harder than Canary Wharf because it has more empty space to absorb at a time when tenants are looking to cut back.
Near the end of London's last commercial real estate recession in 1992 there were about 200,000 people in financial services-related jobs in central London. Last year that number reached a peak of 349,000 and is expected to fall back to around 330,000 by the end of 2009, little more than the 323,000 people employed in 2000, according to the Centre for Economic and Business Research.
Canary Wharf has lured banks such as HSBC Holdings Plc and Barclays Plc, which have their global headquarters there. Securities firms including Citigroup Inc, Morgan Stanley and Lehman Brothers Holdings Inc have their European operations on the 90-acre estate, now controlled by a group including Morgan Stanley and New York investor Simon Glick. A total of 90,000 people work there for financial companies.
Seeking Skyscrapers: Former London Mayor Ken Livingstone, ousted in May after eight years, encouraged developers to build skyscrapers in the City to relieve pressure on space. In 2003, he announced plans to add as many as 15 towers by 2013 to protect existing green spaces and add affordable housing.
Critics said new tall buildings in central London should be confined to existing clusters and to Canary Wharf. Boris Johnson, the new mayor, endorsed that view last month in a consultation document that said he would “support tall buildings in appropriate locations.”
Even as the City struggles with tighter lending and fewer tenants, British Land will next month complete the Broadgate Tower, which is about 42 per cent leased. Others under construction include the 945-foot Pinnacle, more widely known as the Helter-Skelter, on Bishopsgate, and the Heron Tower. Another due to be built is the Shard, just outside the City.
The delay in starts on proposed office blocks where construction isn't under way may help sustain the market by preventing capital values and rents from falling further, according to Savvas Savouri, head of research at BH2, a brokerage that specializes in selling properties in central London.
‘Bad Economics’
“It's not like rents are spectacularly high or unsustainable,” said Savouri. “The idea that rents will come crashing down is just bad economics.”
Rents peaked at the end of last year at £65 a square foot, the same level as in 1988. Adjusted for inflation, City office rents are 33 per cent lower than in 1975, said Peter Damesick, head of UK research at CB Richard Ellis.
Rents have already fallen to £58.50 square foot and may fall to £50 by the end of next year, said Damesick.
The availability rate in the City, which includes empty space and space under construction that hasn't been leased, will peak in the “mid- to low teens” within the next two years, compared with 8 per cent at the end of the first quarter, he said. That compares with a high of 16 per cent in 2003 and around 20 per cent in the early 1990s.
Different Cycle?: With the proportion of empty office space in the City about half what it was in 1990, larger landlords such as British Land and Hammerson, which is redeveloping the former London Stock Exchange building in Old Broad Street, may be better equipped to cope with the decline, said Simon McGinn, head of the property advisory team at the City of London municipality, in an interview.
“The feeling is this cycle is different in a number of ways,” said McGinn. “Vacancy rates are much lower than they were then, while at that time there was a lot of speculative development in expectation of banks starting operations in London.”
Low interest rates may also help REITS better withstand the decline compared with the recession in the early 1990s, said JPMorgan Chase analyst Harm Meijer. UK interest rates at the start of 1990 were 14 per cent compared with 5 per cent now.
Developers who are building without tenants lined up or with few commitments may be the most vulnerable, Meijer said.
Minerva Deal
Minerva Plc, the U.K. developer of two London office towers with less than 10 percent of space leased before completion, last month received a 258 million-pound takeover offer from Limitless LLC, Dubai's state-owned developer.
Minerva's two largest developments, Walbrook and St. Botolphs, are in the City. St. Botolphs will have 560,000 square feet when completed in 2010.
Shares of Minerva have lost more than half their value in the last year on investor concern that Minerva could fail. The stock is now trading at almost 25 percent less than Limitless's offer of 160 pence a share.
Developers' shares have already fallen more during this slump than in the last one from 1990 to 1992.
Land Securities fell 17 percent in the same three years, less than half the 45 percent slump since the start of 2007. British Land has fallen 59 percent since the start of 2007, compared with 52 percent in the three years to Dec. 31, 1992.
''We expect U.K. property values, and hence property shares, to be dragged down by rent foreclosures on highly leveraged property vehicles and falling rents as the economy slides into recession,'' said Morgan Stanley's Allen.