Bloomberg News

Edinburgh Money Lured by Forecasts of Rising London Rents

November 23, 2011

Nov. 22 (Bloomberg) -- Standard Life Investments and Scottish Widows Investment Partnership, Edinburgh’s largest property managers, are investing in London and south-east England commercial buildings on expectations that rents will rise faster than in other parts of the country.

“It’s going to be pretty solid in terms of the returns, which will average about 7 percent a year over the next five years,” said Gerry Ferguson, who manages the 2.3 billion-pound ($3.6 billion) Scottish Widows Investment Partnership Property Trust, the U.K.’s largest property mutual fund. “Those are pretty attractive numbers.”

Standard Life Investments, which oversees 10.4 billion pounds of property assets, aims for annual returns of about 6.5 percent over three years, said David Paine, head of real estate at Edinburgh’s largest money manager. “We are a little more conservative than some in the short term,” Paine said in an interview. “The vast bulk of the returns will come from cash.”

A slowdown in office development in London through 2015 will result in “insufficient supply to satisfy even low demand,” preventing rents from falling. British Land Co. said in September. A scarcity of available commercial real estate in central London caused average prices there to increase in October, Investment Property Databank Ltd. said Nov. 14, while there were declines in the rest of the country.

Unwanted Assets

Values of office, stores and warehouses are still 34 percent below their June 2007 peak after rising just 1.7 percent in the 12 months to October, according to IPD data. Banks are struggling to sell unwanted property assets at book value and are attaching tougher conditions on loans to new borrowers.

The next two years may be even more challenging, with prices falling as much as 4 percent before rebounding, Ferguson said in an interview. “It’s all about income,” he said.

Ferguson expects rents to rise by an average of 2 percent a year over the next five years, more than double the increase in values.

Real-estate stocks offer good value on a “very selective” basis and look attractive relative to bond returns, Paine said. “If you can get the right asset and the right kind of income security, it is the right time to buy,” he said.

Better Than Bonds

Both money managers are looking at property positively relative to bonds. “If you can get the right asset and the right kind of income security, it’s the right time to buy,” Paine said.

The spread between the yields on real estate compared with the yields available on 10-year U.K. government bonds is as wide as it’s been in at least 22 years, Bloomberg data show.

The yield on U.K. commercial real-estate at Oct. 31 was 6.2 percent, according to IPD, while the current 10-year benchmark gilt yield was 2.195 percent at the close in London yesterday, a spread of about 400 basis points. That compares with 12 basis points at the end of 2007.

Standard Life and SWIP, which oversees 8.1 billion pounds of real estate, are investing with a focus on prime assets in London and the southeast of England. “Good quality” regional shopping malls and retail parks with tenants on long leases look good value over the next three years, Paine said.

“You have this divergence between prime and secondary, which is becoming even more acute,” he said. Prime properties are good-quality buildings in favorable locations, while secondary ones are often older, in need of renovation and in less attractive locations.

Still, Ferguson and Paine are talking to the banks and would consider buying secondary properties as long as the pricing reflects the risks and there is enough demand from tenants to sustain the rental income.

Speculative

SWIP’s property trust is investing 50 million pounds in a speculative office development in Hammersmith, west London, where no tenants have been signed up so far. “We have a number of developments on the drawing board,” Ferguson said.

They include a vacant office block in London that it plans to turn into a hotel and a 25 million-pound private hospital in Brighton in southern England.

“We have experience of development,” Ferguson said. “We know the risks involved.”

Most of Standard Life Investments’ property funds don’t have any leverage, partly because of the difficulty in getting loans at all or on terms that make sense, Paine said.

“Having no gearing is a good place to be at the moment,” Paine said. “It puts us in a good position if we want to gear up.”

--Editors: Tim Farrand, Andrew Blackman.

To contact the reporter on this story: Peter Woodifield in Edinburgh at pwoodifield@bloomberg.net.

To contact the editor responsible for this story: Colin Keatinge at ckeatinge@bloomberg.net.


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