Hey, Where Did All The Americans In London Go?

London saw more commercial real estate investment than any other city in the world in 2017, according to JLL. But there is one group of investors finding it increasingly difficult to invest in the U.K. capital.

North American investors, from the U.S. in particular, were a dominant force in London as the market recovered after the credit crunch, with firms like Blackstone, Brookfield and Oxford Properties becoming huge players.

But North American investment in London is down 69% compared to its 2015 peak, according to data from Real Capital Analytics. U.S. investment into London is down 55% in that period. North American investors made up £3.6B of the £23.2B invested in London in 2017.

U.S. investors are awash with cash, but they are not spending it in London because for many of them London offers kind of the opposite of a sweet spot — prices are high but certainty about things like rental growth is at a low. Buyers from some countries can handle that, but North American investors are looking elsewhere. Or, if they are investing in London real estate, they are doing so via increasingly complex routes.

“The main thing here is the point we are at in the cycle,” Savills Head of Cross Border Investment Rasheed Hassan said. “For core and core-plus assets the returns they can achieve in London are not acceptable for them. And for opportunistic and value-add investors, underwriting riskier assets has become a lot more uncertain since Brexit.”

This latter point is key. The vast majority of North American investors in London have been opportunity funds like Blackstone, Brookfield and their peers, with the notable exception of big Canadian pension funds like Oxford and Ivanhoé Cambridge.

It is not like London was cheap in 2015 when these groups were piling in — prices have risen 10% since then, according to RCA, but 2015 prices were still much higher than the long-term average.

But at that point forecasts were for rental rises in London due to continuing robust economic growth, and debt was plentiful for any type of asset. Brexit has changed both of those things, removing the lifeblood of value-add and opportunistic investors.

“If you buy a building with two years' income with the intention of refurbishing or redeveloping it and then selling it, you have to underwrite what rents will do over the next three to four years. Rents and values haven’t dropped since Brexit in the way that some people expected, but some investors are now being a lot more conservative on that,” Hassan said. “The financing market for risk assets is a lot more challenging now. If you’re a bank, you might now think, do I really want to be involved in a refurbishment deal where I’m not receiving income for a few years?”

There is an analytical element, but a human element, too. Given the amount of uncertainty around the U.K. in the wake of Brexit, London can seem more trouble than it is worth.

“About nine months to a year ago, we started hearing from managers that they didn’t want to take London and U.K. deals to their investment committees,” Hodes Weill partner Will Rowson said. “There was a feeling that people didn’t want to be outside of the general consensus about London even if they liked an individual deal.”

It has been clear for some time that Asian investors are dominating the market for trophy assets in London — RCA data shows that Hong Kong investors alone accounted for more than 50% of London’s investment market.

But they are also outbidding North American investors on higher-risk, higher-return deals. Hassan pointed to the purchase of the Regent Quarter, reported to have been bought by Hong Kong investor Nan Fung for £270M. The 30-building campus needs refurbishment and re-leasing and is exactly the kind of deal North American investors would typically snaffle up, and indeed several were underbidders on the deal.

“The market is awash with capital from elsewhere,” RCA Senior Director of EMEA Analytics Tom Leahy said. “Yields in Hong Kong are almost twice as low as in London, and investors from Asia have a different rationale and return requirement.”

Hold term is the key ingredient: Leahy said Asian investors will take on more risk because they will hold the assets longer, whereas private equity funds typically have a maximum seven-year investment period.

So where are the Americans investing in Europe right now? The answer, somewhat surprisingly, is Finland. Spain, Germany and Finland were the top three destinations in Europe for North American investors, Leahy said.

“In Spain you saw a lot more distress situations coming out last year, which appeals to the private equity players. In Germany prices are high but you have the expectation of growth. And Finland is one of the markets that has lagged the rest of Europe so there is still the perception that there is value there.”

Blackstone invested more in Spain last year than all U.S. investors in London combined and took Finnish listed company Sponda private in a £1.6B deal.

North American investors who are investing in London are finding increasingly esoteric ways as the market reaches a late-cycle stage.

Examples of corporate deals are Blackstone’s purchase of a majority stake in flexible office firm The Office Group in a deal that valued the company at £500M. It does not own the real estate, but it is a way of accessing an area of growth in London.

Similarly Brookfield is looking to purchase private serviced office company IWG, which has a large London presence. It is also lending to complex London development deals, for example providing a £225M loan to a 300K SF speculative office development being undertaken by CIT on the edge of the City. The return from a lending deal is not as high as lending to development itself, but the risk is also lower.

Even the deals where U.S. firms are buying the actual real estate are complex and in alternative sectors. For example, the largest deal by a U.S. investor in London last year was the £550M purchase of The Grosvenor House Hotel, bought out of bankruptcy by Ashkenazy Acquisition after the previous owner needed to sell to fund his bail.

“[U.S. investors] are pregnant with cash and they haven’t called the market,” Hassan said.

For everything you need to know about capital flows in London come to Bisnow's London 2018 Forecast event on 22 February at 7.30am at Merchant Taylor's Hall.