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Wall Street Journal / Biz - Money

London Real Estate Divide Highlights Sector’s Uncertainty in 2018

Some investors view falling prices in London as a buying opportunity, while others are moving to the sidelines. The different approaches underscore the challenges facing real-estate investors in 2018.


By

Olga Cotaga

About three years ago, Hines stopped investing in London commercial real estate and started selling its property there because the Houston-based developer correctly believed prices had gotten too high and were soon headed south.

Today, Hines is back looking for deals and expects to start buying again in 2018. “The discounts are starting to get bigger,” said Lars Huber, chief executive of the firm’s European operation. “We are underwriting deals now.”

A much different approach to London is being taken by CBRE Global Investors, with $98.3 billion of assets under management. “We are going to see rents struggling,” said Andrew Angeli, head of U.K. research at the firm. “We will be net sellers.”

All markets, of course, have bulls and bears often depending on such factors as investors’ return objectives and risk appetites. But, as 2018 gets under way, nowhere are the opinions more extreme than they are in London.

That is because, unlike most markets in the U.S., Europe and Asia, London commercial real estate has gone through a correction. Private market values of office and residential property in Central London are 5% to 10% below peak, according to Green Street Advisors. Shares of public landlords are trading at levels that imply a 20% to 30% decline, the firm said in an October report.

That decline makes London attractive to those who think values have hit bottom but dangerous to others who think there is more pain to come. The outlook is clouded further by the likelihood that interest rates will rise and the widespread belief that the U.S. and other western markets are due for a correction after a nine-year bull run.

CBRE is asking its portfolio managers “what property you would not hold in a recession,” Mr. Angeli said.

Whether it is booming or busting, London has long been one of the most active commercial property markets in the world. The city has been popular with foreign investors thanks to its size, diverse population and status as a global financial hub.

Prices fell sharply after the 2008 global financial crisis but recovered as investors moved in to snap up bargains. About three years ago, when values of some office buildings and apartments were in record territory, the market began to soften.

That softening accelerated after the U.K. voted to leave the European Union in June 2016. Prices of office buildings, apartments and other properties fell sharply as investors worried about employers and residents leaving London for other European cities that remained in the Union.

Before Brexit, demand was strong for properties with coming vacancies because investors assumed that they would be able to fill the space with tenants paying higher rents. After Brexit the market attitude “took a 180 degree turn,” Mr. Huber said. “Vacancy became a threat.”

To be sure, the post-Brexit downturn hasn’t been as bad as many feared. This is partly because foreign-investor demand has remained strong for trophy, well-leased property.

Indeed, sales volume in the City of London reached £12.5 billion ($16.9 billion) in 2017, more than 50% up compared with 2016, according to Savills . That rise was largely due to the sale of two well-known office buildings—nicknamed the Walkie Talkie and the Cheesegrater because of their shapes—to Hong Kong-based LKK Health Products Group and  CC Land Holdings Ltd . , backed by a China property tycoon, respectively.

“If that capital would not have been there, I’m quite sure values would have dropped in London,” said Rogier Quirijns, senior vice president at investment manager Cohen & Steers.

But it isn’t clear whether foreign demand for trophy property will stay strong in 2018. Some players from mainland China, like Dalian Wanda Group, have faded from the scene because of measures enacted by the Chinese government in late 2016 to curb outbound investment.

Rents and occupancies also will likely come under pressure this year from new supply. About 7.3 million square feet of office space is expected to be delivered this year from new developments and refurbishments on top of the 8.9 million square feet built in 2017, according to BNP Paribas Real Estate.

In the sales market, there might be a surge in listings from owners wanting to sell before a new capital-gains tax goes into effect in April 2019 that hits investors who own or sell commercial property via offshore vehicles. This could put additional downward pressure on prices if demand falls off.

Savills said it was monitoring £4.4 billion of commercial property listings in the City of London. Deals worth about £3.95 billion currently are under contracts that haven’t yet been closed, the firm said.

Brexit’s impact on the London market probably won’t be known for years partly because details of the divorce are still being negotiated. But there are additional political uncertainties on investors’ minds, including the possibility of a Labour Party government led by Jeremy Corbyn taking power.

Some feel that government would be less friendly to business than the current one led by Theresa May, the head of the Conservative Party. “They [investors] say Brexit doesn’t bother them, but [Mr.] Corbyn does,” Mr. Angeli said.

Hines believes there are buying opportunities in London, particularly with properties that have vacant space or face other leasing challenges. The value of these properties have fallen about 10%, compared with where they were three years ago.

These properties only attract a “thin field” when they are put up for sale, Mr. Huber said. “It’s a market that has softened and no one really knows exactly when is the turning point,” he said.

—Peter Grant contributed to this article.

Write to Olga Cotaga at Olga.Cotaga@wsj.com

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