November 22, 2012 7:41 pm

Property: The lure of London

Asian investors drawn by low prices have helped make the city a coveted commercial market
Battersea Power Station©Corbis

Battersea Power Station, which was bought by a Malaysian consortium for £400m early this year

Towering over the south bank of the Thames, Battersea Power Station has enthralled – and frustrated – a procession of property developers in the 30 years since it was decommissioned.

The coal-powered plant, with its four distinctive chimneys, once generated a fifth of London’s electricity. It looms large in the public imagination, having served as a backdrop for Alfred Hitchcock’s Sabotage and in the cover art for Pink Floyd’s Animals LP. But highly publicised efforts to turn it into a hotel, a football stadium and a theme park have all flunked.

Today, however, a new generation of Malaysian developers is placing an £8bn bet on turning Europe’s largest brick building into a 39-acre complex of apartments, shops and offices.

On a crisp September night, a 160-strong delegation of the building’s new owners gathered inside its rotting bowels to launch the project. The occasion was deliberately low-key. Boris Johnson, London’s flamboyant mayor, rattled off a light-hearted speech about the transformative power of the newcomers’ money to the neglected part of south London.

“The Malaysians didn’t care about being flashy,” recalls one guest. “It wasn’t a ‘look at these nice architect drawings, eat some canapés and cross your fingers’ vibe. The message was: ‘We are here and we are going to do this – now let us get on with it’.”

For the Malaysians, there is a sound basis for their confidence. The country has spearheaded a buying spree in which Asian investment funds, ex­cluding Indians, have ploughed £2.4bn into central London so far this year – nearly four times the total for 2010. They have snapped up skyscrapers, Art Deco newspaper offices and development land on the city’s fringes.

Mere bit-part players just two years ago, buyers including the Chinese government, funds helping Malaysian Muslims save for a pilgrimage to Mecca and an Indonesian palm-oil billionaire have stumped up a quarter of all transactions by value in the City’s commercial property market.

So strong is demand that London has brushed off Europe’s economic crisis to become the world’s most coveted property market, cornering £13.2bn of £177bn spent globally this year. The sum is higher than that invested in any European country, according to data from Real Capital Analytics. It is almost as much as the combined £14.7bn spent in its rival cities of New York and Paris.

Offline Battersea still generates a crackle

Battersea Power Station has played an outsized role in London life.

Perched imposingly on the south bank of the river Thames, the hulking brick box very nearly did not get built. Protestations against the 1920s plan to amalgamate London’s nine power stations into one “super-station” included worries that pollution would destroy artworks at the nearby Tate Gallery.

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But the appeal of Europe’s most populous city to Asia’s newly rich states baffles many in the global property industry. Why, they ask, is the cash not flowing to other “safe” cities – in Germany, say, or Holland or the rebounding US? And why is more not being spent closer to home? Malaysia’s three largest investment funds, for instance, allocated just 17 per cent of their foreign property outlay to southeast Asian assets in 2011.

The reason is price: London is cheap. When the market started to fall in late 2007, UK institutions began to value their property portfolios every two weeks. The idea was to use transparency to mitigate uncertainty. In reality, the practice laid London open to fierce scrutiny that sucked billions of pounds from the market.

In the two years from mid-2007, building values collapsed by 55 per cent in the City of London and by 57 per cent in the West End. London suffered a greater peak-to-trough decline than anywhere in Europe other than Madrid. The decline was offset by the weakness of the pound. A Singaporean, Chinese or Malaysian buyer of London offices would have experienced a peak-to-trough decline of nearly 70 per cent once currency savings had been factored in, according to data from Jones Lang LaSalle, the property consultancy.

Competition for the best assets has also declined. In October, a month after the Battersea launch, analysts from Kenanga Investment Bank in Malaysia arrived in London to assess the market. After two days of tramping between building sites and boardrooms, the analysts concluded: “London is an evergreen market, but the lending environment is tight, which prices out many locals.”

However, there is also a more significant structural change in London property. In the city’s domestic market, landlords have been in “net disinvestment mode” for nine of the past 10 years. And in 2011, for the first time, the City property market was majority owned by foreign entities.

Politics have smoothed this shift. The Conservative-led coalition has so far restricted increases in stamp duty to the housing market. In addition, London is free, at least for now, from the uncertainty roiling the eurozone.

Matthew Richards of JLL says the appeal is in part cultural. “These quasi-government funds have huge pools of money to get through. A lot of the guys running them were educated in the UK, so when they are given the green light to invest overseas, London is an obvious starting place.

Beyond that, he says: “A lot of it is herd mentality, and if one or two big deals get done in Paris or Frankfurt, then more money will start to flow towards those markets, too.”

Thus far, however, it has not. Malaysian funds – the most active of all Asian investors in London – have poured £1.5bn into the market, accounting for three of the five largest transactions from the region in the past 12 months. Similarly, China Investment Corporation, Beijing’s investment arm, recently made its first foray into European property ownership, buying Deutsche Bank’s £245m City headquarters.

But while they are attracted to London for similar reasons, there are myriad differences in the way Asian investors operate once they arrive. In 2009 South Korea’s National Pension Service paid £772.5m for HSBC’s headquarters in Canary Wharf, the financial district to the east of the City. The market waited, expecting the rest of the region to follow suit. Nothing happened for three years.

Tony McCurley of GM Real Estate, an agency specialising in central London, has helped buyers from across Asia find property amid the Square Mile’s lanes and courtyards. He points out that while the type of building being sought – typically high-quality offices with long leases – might be similar, the approach to dealmaking can vary widely. “As active players in this market, we have to be fast at understanding the nuances between the different Asian investors and how they evaluate pricing,” he says.

Another London agent says: “The Malaysians are good as gold. Once you have agreed on a number, they won’t change it. But I was doing a deal with a Korean fund recently and the price kept on being moved about. I got so pissed off that I went online and looked up ‘how to do business with Koreans’. It said that this kind of thing was fairly standard practice.”

There is, though, one factor that links Muslim buyers from Malaysia and China’s sovereign wealth funds with Indonesia’s super-rich and the pension funds of Singapore. They all value property differently from European and US investors.

Western buyers value property on what is known as “total return” – a combination of the income from rent and appreciation in the underlying value of the building. Asian investors focus only on rental income, favouring buildings with a reliable tenant and a lease with many years to run.

This fundamental difference in valuation treatment underpins the power shift at the heart of London’s property market. “A buyer looking only for rent is treating the building like a bond to hold to maturity,” explains Mr Richards. “If a western buyer takes the same building to the credit committee, the first thing they want to know is what is it going to be worth in five years. He adds: “In simple terms, it means a buyer of rent can afford to pay more because they do not have to factor in the bet that the value of the asset will rise.”

. . .

With its dense layers of banks and insurers, the London office market is a fertile hunting ground for risk-averse landlords seeking tenants unlikely to skip rent payments. Even for the emerging class of sharia-compliant investors – forbidden from owning property whose tenants engage in finance – there is no shortage of tech companies and law firms.

The final piece of the jigsaw in attracting Asian long-term investors is the unusual structure of property ownership in London. Under English property law, most commercial leases are known as “triple net”, meaning the tenant is responsible for rent, building insurance and maintenance. The structure has fostered an increase in remote landlords in the City.

“When we go to Hong Kong, Kuala Lumpur or Seoul to market these buildings, the first thing prospective buyers want to know is who the tenant is and how long are they signed up for. They are obsessed with it,” says Alistair Elliott of Knight Frank, a property consultancy.

He adds that the rapid change in London’s buyer mix has caught some in the industry off-guard. “If you were selling a £100m building a decade ago, you could identify exactly who would be on the list of potential bidders. Today, there could be three on the list that you have never heard of.”

Concern is also growing in UK property circles that the new entrants will suck liquidity from the London property market, damaging its investment haven status. With the larger Asian funds buying property on a 15- to 20-year view – far longer than is normal for European or US investors – some of London’s most coveted buildings could be off the market for a while.

But after the jolts of the past decade, many old hands in the London market happy to see the arrival of what appears to be a force for stability. The last boom was led by Irish investors, who bought up dozens of London properties, including Battersea Power Station, using billions of pounds of loosely peddled bank debt.

“Many played it like a casino with someone else’s money,” says Mr McCurley. “When the market tipped over, they were massively overleveraged, went bust and took the main Irish banks down with them. The Asians seem a lot more sensible.”

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