September 12th, 2007
Gherkin sold. London’s commercial property market is booming, and
Never mind houses in Belgravia, the price of top commercial property in London just keeps on rising too. To prove the point, along comes the sale by Swiss Re of Lord Foster’s iconic, but for most purposes hopelessly impractical, “Gherkin” in the heart of the City for [pound]630m. This is the most a single office block in the UK has ever fetched. Nor is the record expected to stand for long. With both CityPoint, on the western side of the City, and HSBC’s Canary Wharf headquarters on the market too, bigger numbers still may soon be making headlines.
Do these record-breaking values signal the top of an already overheated market, or are they just the going rate for an ever more sought-after London market, rather in the same way as the [pound]1m house? This was once an extreme rarity too, but in London, at least, is now the price of an even quite modest dwelling in a Victorian terrace.
Office property in Britain obeys many of the same laws as the residential housing market. In good times, there is the same pressure of demand on limited supply. As prices rise, a construction boom gets under way with the consequent glut of new property generally coming on to the market just as the economy begins to go south. Everybody then struggles in the subsequent downturn. Only this time, it does-n’t seem to be working that way. Rising interest rates have failed to put any kind of a noticeable brake on the price of commercial property. Nor, as long as the City keeps booming, and foreigners keep wanting to invest their money here, are they likely to.
Part of the price that has to be paid (or perhaps it should be referred to as a dividend rather than a price) for the City’s success as an international financial centre is that seemingly everyone wants to come and locate here. As a consequence, prices are going up, particularly for prime property of the type that the highly skilled demand to work in. But so are rents. Yields are thus, broadly speaking, keeping pace.
The present phase of pressure of demand on constrained supply has coincided with a secular change in investment attitudes to commercial property. No longer is property regarded as the unsafe asset class, prone to boom and bust, it once was. Instead it has come to be regarded as a store of value which delivers a reliable, if unspectacular, income stream largely protected from the vagaries of inflation.
Just right, in other words, for maturing pension funds and the growing ranks of other risk-averse investors. If it comes to a toss- up between an inflation-linked gilt and a prime City property, I know where I would rather stick my money. Yields, even at recent valuations, are still reasonable, while rent reviews provide a perfect hedge against inflation.
There are other attractions, too. Law of contract together with the existence of deep and liquid markets makes Britain a honey-pot for foreign money, especially the petrodollars of the Middle East and Russia. This is perhaps just as well, since the consequent capital inflows support a current account deficit that would undoubtedly sink the pound in most other circumstances. London’s commercial property market is supported in the same manner as the residential housing market by a wall of foreign and City money. As long as this remains the case, the property market will continue to boom.
The more favourable tax treatment for commercial property brought about by the introduction of Real Estate Investment Trusts will help further underpin the market with institutional money. It’s a big price to pay for a gherkin, which is bound to invite parallels with the Tokyo property boom of the late 1980s. For the time being, the London sequel appears much better supported by the fundamentals.