The law firm examines the allure - and risks - of London prime property for family offices.
The following item is by James Dakin, a partner at Boodle Hatfield. Dakin is a banking and finance lawyer advising across a broad range of sectors, including property finance, acquisition finance, asset based lending, general corporate lending, structured finance and restructuring. In this article, he looks at the prime central London property market. This market has seen big price rises in recent years, prompting political figures, for example, to call for taxes on the sector. The comments here are Dakin’s own and not necessarily those of the editors of this news service.
Property has always been an attractive asset class and one of the key themes of recent years has been the popularity of prime central London property, particularly high-end residential property and “trophy” commercial assets such as Bond Street retail.
To understand why family offices sit at the heart of this trend, it is first necessary to examine purchasers’ motivations for these kinds of acquisitions. Research has shown that each successive wave of uncertainty abroad has prompted new capital to flow into London property. The eurozone crisis led to continental European high net worth individuals making acquisitions, concerns over the direction of President Hollande’s policies has led to a large influx of French purchasers, and the Russian annexation of Crimea brought an upturn in interest from Ukrainian buyers. All the while there has been a constant flow of Russian and Chinese money.
The reason for this, quite simply, is that London is seen as a safe haven for capital.
First, Britain has a long and uninterrupted history of political stability, recognition of property rights and maintenance of the rule of law. This gives families the confidence that assets purchased in London will not be confiscated.
Secondly, taxes on capital are low and acquisitions can be structured efficiently to minimise their impact. Whilst there has been some tightening in recent years, Britain remains an attractive investment location for people domiciled abroad.
Last, London has become a centre of excellence for ultra high net worth individuals. From restaurants and galleries, through schools and universities, to wealth management and professional services, London has a critical mass that few rivals can match.
This means that, in many cases, prime central London property is bought with more of an eye to capital preservation than to income. Indeed, weight of money has pushed prices to a level where returns-driven investors cannot compete. Yields on trophy commercial assets in the West End of London are routinely under four per cent. Many of the flats and houses bought in prime areas are occupied for only a few weeks in the year and seldom let out.
Whilst valuations look heady, the motivations of the purchasers suggest that a crash is unlikely. Overwhelmingly, these assets are bought to be held indefinitely and passed down the generations. This tends to suggest that supply will remain limited, with new development forming a large proportion of available units. Perhaps the main concern is the political climate in the UK. Politicians will feel pressure to raise more taxes from the wealthy but must resist courses of action that could kill the golden goose. Britain’s reputation for fairness and the rule of law has taken centuries to establish and must not be risked for short-term electoral advantage.
There are two significant trends in the market at the moment for those family offices looking for good income returns from property - one being the financing of prime residential property development (rather than buying the finished product), the other being investment in the private rented sector.
We have seen a significant increase in family offices investing heavily in prime residential development both as investors and as lenders. The debt side is evolving particularly fast, with UHNW individuals sometimes investing through their own and multi-family offices and sometimes through platforms established by experienced bankers acting as conduits for family money. This trend is particularly welcome because mainstream lenders have been retrenching and are often reluctant to take development risk. For those UHNW individuals prepared to move up the risk curve, there are double-digit returns to be made from mezzanine financing, with loans typically being repaid within two years. The biggest risks in this type of investment are a change in market climate impairing sales of finished units and investment in projects that might take a long time to sell.
The other area which is attracting considerable interest from family offices is the private rental sector - building flats and houses for rent to the mid-market.
The enthusiasm for this burgeoning sector is backed by demographics: the population of London is growing fast, as is the demand for reasonably-priced rented accommodation in those London boroughs close to the City and the West End: zones 2 and 3. This is an underdeveloped sector in Britain, with rental accommodation at the moment being largely either affordable housing run by local authorities and housing associations or small-scale buy-to-let investment.
The private rental sector vision is to create large-scale mid-market communities which in due course will become an institutional asset class, once a track record has been established. The opportunity for family offices is to participate in establishing the track record which should lead to increasing values when the institutions enter in due course. Unlike institutions, which have to justify investment on the basis of established data (which does not yet exist for the private rental sector), UHNWs are able to take the long-term views necessary to establish this sector.
Outside of London, the property market is much less vibrant. Areas which show some signs of life include regional offices and shopping centres where the price is sufficiently low to be tempting, but the occupational market for such properties is poor, so investors must be extremely selective. One popular investment at present is in distribution centres let to strong covenants. These assets tend to be well-located adjacent to motorways and demand is underpinned by the shift to online shopping. Another emerging trend is strategic land for housing - taking a long-term view on where the next generation of urban extensions is going to be built. The capital gains on such investments can be spectacular, though the process is long and uncertain.