Lipton, Burns, Partridge, Marcus, Houston And Sinclair: What 6 Real Estate Sages Think About Where We Are In The Cycle
History tells us that property is cyclical, and the good times have to end. But when, and for what reason? It is the question that dominates conversations among real estate investors.
Property values had a huge bull run from March 2009 until the end of 2015, and even post-Brexit, rents and values in most sectors have proved resilient.
Who better to answer the question of where we are in the cycle than a group of real estate veterans who have each seen not just one or two but in most cases three cycles of boom and bust? Ahead of November's London State of the Market event, Bisnow asked a group of “seasoned” industry figures what they thought about the current cycle and how they are positioning their businesses. Among them they have more than 250 years of experience in the real estate industry.
Their view is that, in a nutshell, there is no need to panic yet — the fundamentals of London real estate and the wider U.K. industry look OK for now. But unprecedented social change, shifts in the way people work, and personal and government debt make predictions a dangerous game.
Sir Stuart Lipton — Lipton Rogers
Sir Stuart Lipton has been a developer in London since the 1960s, and schemes he has built include Broadgate in the City and Chiswick Park in West London. Today Lipton Rogers is development manager of the 1.35M SF Twentytwo office scheme in the City.
“I’ve never seen more change at any time in my career. I don’t want to oversimplify, but [the late 1980s/early 1990s crash] was all about oversupply and lack of finance, and 2007 was the same. Today there is as much money around as I’ve ever seen, no one is over-borrowing and the demand for offices is still there. But it’s never been harder to read what's going on.
We have changed our lifestyles, the way we live, the way we work, so we have an obligation to change the way we develop, to provide the amenities that people want, and truly incorporate the way technology is changing the way we live.”
“Property has become mired in complexity — dilapidations, upwards only leases that take six months to agree and sign, office fit-outs that don’t reflect technology. WeWork has come along and simplified that, and we have to react. Today, companies want space that is cost-effective and is efficient, and there is a shortage of that kind of space, and when you look around London there is not much of it being built. The kind of product we need has changed and I worry there is a shortage of skills needed to build it.
A lot of office space will continue to be converted to residential, and combined with the current planning system I think that will mean rents can continue to rise. But the real question is where will the growth come from? It is not in retail, office is changing, in resi there is growth but at the wrong price point, so where growth comes from is the challenge. People say biotech could be bigger than tech, so you can build for that sector, but it is a challenge.”
Ian Marcus — Eastdil, The Crown Estate and others
Ian Marcus began his career in real estate banking at County Bank in the early 1980s and worked as a real estate investment banker at Bank of America, UBS, NatWest and Bankers Trust/Deutsche. In 1999 he set Credit Suisse’s European real estate investment banking business, of which he became chairman. Today he sits on the boards of numerous property companies, including the Crown Estate, and is a senior advisor to Eastdil Secured in Europe.
“The first thing to say is well done for recognising that real estate is a cyclical business and will always remain one. As soon as someone says, this time it’s different, that is the time to start worrying. There are many examples of fast-growing companies that are trying to change the world, and I am not sure they recognise the cyclicality of the sector they operate in.
Each time, the cycle is different in some shape or form. Fundamentally the real estate market is driven by supply and demand and the world geopolitical and economic situation. We live in a genuinely global system today — we are affected by what happens in other parts of the world, and they are affected by us. Combined with the speed and greater transparency you have in real estate today, that means greater volatility and the response to changes in circumstances will be more rapid.
The theme of the week, the month, the year is that at last the industry has recognised that it is a service provider, and is slowly moving away from the adversarial world of landlords and tenants. The industry is having to react and become more like hospitality, and respond to a fast-changing world, not just in the sense of technology, but recognising it is providing a service to people.”
“The holy grail for real estate for a long time has been to take what is a heterogeneous, illiquid product and create a homogeneous, liquid market. That’s what REITs were trying to do, and also products like IPSX, and anything that creates greater liquidity and transparency are generally good. But you have to be careful what you wish for. Real estate is not the same as equity. I worry about things like peer-to-peer lending and crowdfunding, which attract less sophisticated investors into the market who think they know about it but don’t. I worry that we are sowing the seeds of the next derivatives or financial engineering issue. It has taken real estate 30 years to earn its place at the asset allocation table, and I don’t want it to do anything that might lose that place. Previously real estate has been tolerated in the good times and blamed in the bad times. There haven’t really been crises where real estate wasn’t at the centre of the issue.
I remain naively optimistic. At the moment, whatever happens, the weight of money argument seems to win out. Global investors are increasing their allocation to real estate, and the U.K. seems an attractive destination. We think we've got problems, but if you sit in the Middle East or Asia, the U.K. can seem pretty stable and offers good risk-adjusted returns. You have to put it in a global context. London remains a global capital for different sorts of investors looking for capital preservation.
This cycle feels different because if you look at the fundamentals then you can’t justify the pricing, but it continues. It is the weight of money argument, and it is all driven by the long-term low interest rate environment. The big difference is that the banks have been significantly chastened by past experience and they are not making the same mistakes again. If you look at the last crash, about two-thirds of all debt came from the Irish and Scottish banks, so that is five banks. Today, you have more than 200 different capital providers, and that diversity means you shouldn’t have the systemic problems of last time.”
John Burns — Derwent London
John Burns began his career at agency firm Hiller Parker in 1961 at the age of 17. He continued in the agency world until setting up an investment business, Derwent Valley, in 1984 alongside longtime partner Simon Silver. Today the specialist London investor and developer has become Derwent London, is part of the FTSE 250 and has a market capitalisation of £3.3B.
“Why is today different to previous cycles? Firstly you have the low interest rate cycle that’s gone on for a long time, and is likely to stay that way for some time yet. That makes property a more attractive investment.
Also, in previous downturns, you couldn’t get people to even look at office space, let alone take a lease. If you look at the lettings done by us and other companies in the past couple of years, leasing is going OK, especially to international companies. Even through the summer leasing enquiries were very strong. People are taking our buildings, rental growth is not what it was, it is not as stellar, but it is jogging along.”
“The reason why we decided to push the button on new development is because we have very low leverage, and that is true of most companies compared to previous cycles. In the late 1980s things fell off a cliff, rents and values dropped substantially, it was a big shock to everyone, and since then people have become more prudent. In the run up to the '07-'08 crisis most of the debt came from banks, whereas now people are financed with banks but also insurance companies and other long-term lenders. The fundamentals of the banking sector are as strong as I can remember. In the last crisis property was the main offender, banks were encouraged to lend on speculative development, and the property industry took what it could. I think the leadership on both sides won’t let that happen again.
What we’ve done as a result of all this is position the business so that in the event of a downturn we can move ahead and acquire or we can sit on the sidelines. We just try to evaluate risk very carefully and move ahead if the returns are there. You have to be careful not to take things on a very skinny return.”
Robert Houston — St Bride's Managers
Robert Houston is senior partner of St Bride’s Managers. Previously he was the global chairman and chief executive of ING Real Estate Investment Management, one of the world’s largest property investment managers with more than $80B of assets worldwide. Houston has been active in the real estate sector for more than 40 years. In 1980, he founded Rowe & Pitman Property Services which four years later became Baring, Houston & Saunders, which then evolved to become part of the ING Group in 1995.
“We are in different territory now than we’ve ever been in before. Even those of us who have been through the wringer before are not that clear about what will happen or when. Firstly: there will be a crash, and it will be severe. If you ask me when, I would say in the next 10 years. People giggle and say that’s a bit of a cop out. The reason you can’t say for sure it won't be sooner is the Elastoplast theory.
We have seen a huge increase in global indebtedness at a country and an individual level. Maybe it’s not a problem, maybe my grandchildren will always just borrow beyond what they can repay to buy houses or go to university, but unless they are lucky and always have well-paid jobs that will not be the case.
Then there is interconnected nature of the world today. We saw with the Great Financial Crisis just how interconnected we are, and we are now seeing how interconnected we are with Europe, and the difficulty of unwinding the last 20-30 years of economic interconnectedness.”
“You have had so much quantitative easing introduced to the system in the U.S., Europe and Japan, trillions of dollars, that has created an unprecedented degree of indebtedness, it is putting an Elastoplast on a huge gash, and someone is going to have to rip that off. People say, maybe we don’t, maybe this money will never get repaid, but at some point someone will have pull the damn thing off. The bleeding has stopped but the gash is still there. That QE and low interest rates have caused a huge bubble in residential and property prices, and all types of asset price, but we just don’t know what will happen when we rip the plaster off.
However, if you own an investment that you bought at a 4% yield, then over five years you’ve picked up 5% of the value of that investment, and it’s unusual for prime property prices to fall by more than 20% in a downturn. And that gives you a pretty simple theory for why you might keep buying property at a 4% yield. If you buy now at 4% and the crash comes after five years then you are at an advantage, and you will have done a lot better than holding your money in cash. If you think the crash will come sooner, then you shouldn’t buy.
One thing I worry about, and that I don’t think a lot of people in property have got to grips with is the difference between a 100-basis-point rise in yields if you have bought at 4%, and yields move to 5%, and if you have bought at 3% and yields move to 4%. In the latter case the loss of value is far greater and so it is much more likely to negatively affect your returns, and there is far greater likelihood of people breaching banking covenants.”
David Partridge — Argent
David Partridge is managing partner of Argent, developer of the world-renowned King’s Cross Central regeneration scheme, and is also joint chief executive of Argent Related, the company’s London joint venture with giant U.S. developer Related Cos. He joined Argent in 1990, having started his career in 1983 at architecture firm Gebler Tooth Partridge.
“This market doesn’t feel like anything that’s happened before. Every time there’s been a previous cycle before it has tended to come as a result of irrational exuberance off the back of cheap credit, too many people running around borrowing and banks looking to expand their loan book. That led to people overdeveloping office and residential. That was very much the case in both the early 1990s and in 2007-8.
Today, there has never been cheaper credit, and yet that has not resulted in excessive speculative development. Maybe some of the stuff that happened around [real estate lending regulations] slotting, and banks having to account for this loan book in a more reasoned manner, has stopped there being too much lending to the wrong people.”
“There doesn’t seem to be an excess of supply over demand. Maybe in some markets like retail, for all the reasons we know around the high street. But for offices, despite Brexit fears, take-up keeps moving along. King’s Cross is perhaps in a bit of a bubble because companies like Facebook are not overly affected.
People are asking if there will be a slowdown to do with Brexit, and if so will it be an adjustment or a crash. There is still appetite for investment, and incredible yields are still being paid for trophy buildings. The fundamentals are probably not quite right, but because of the investment capital looking for a home you are still seeing deals where the yield starts with a four. At this stage of the cycle you would normally say that is a harbinger of doom, selling offices at 3-4% yields, but this market just doesn’t have the characteristics of anything we’ve been through before. It feels a bit like you are Wile E. Coyote running across the canyon and you are not sure if you will drop or keep going to the other side. Most if us must think we will make it across or we would be unloading all of our development opportunities. There is a bit of a fin de siècle feel about things but it is quite calm and benign.
The worry is if we end up with a hard Brexit and we just crash out of Europe and that ends up leading to a general election or a second referendum. That would result in people sitting on their hands. People would not want to look stupid making a decision in that kind of scenario, and that is when things might adjust. But right now London is still attracting talent — Google, Apple, Facebook, all of those big tech companies want to be here, the startups want to be here, there is a lot of variety in the market, and that dynamic just keeps going. You don’t want to be complacent but it would take something quite drastic to stop that. The big tech companies all have business plans where they say they are going to grow by X% so they need X thousand new people so they need X space, that is how they are working, and if anything at the moment they are behind where they need to be, hence the reason why they are all taking space with WeWork etc.”
Neil Sinclair — Palace Capital
Neil Sinclair is chief executive of listed U.K. investor Palace Capital. He has more than 50 years’ experience in the property sector and has founded several listed property companies including Sinclair Goldsmith Chartered Surveyors, Mission Capital and more recently Palace Capital.
“If you look at the 1970s banking crisis and how banks dealt with it and what happened 10 years ago, it was very different. In the 1970s the Bank of England stepped in and created a lifeboat to support the clearing and secondary banks. The banks basically met and decided who would survive and who wouldn’t. In the 1970s British Land shares were 2p, and it could easily have gone bust. The banks bailed out some property companies and although it was horrendous, there was some sort of order, unlike 10 years ago. The banks handled it very well, very different to the last crash. But in the last crash there was never a situation where you couldn't sell a property — it might have been at a very steep discount but you could sell it. In the 1970s you couldn't sell property no matter what the price.
People are worried about Brexit, but the fact is that the British economy has held up very well, it is still growing, rather than things heading the wrong way. We are finding the letting side more difficult because people are in no rush to make decisions, but people are still doing business.
We are asking, how do we position ourselves as a business over the next one to two years? We are taking the view that there will not be a situation where there isn’t a deal with the EU on Brexit. It may be done at 11.15pm on the 19 March but there is every indication that there will be a deal. We're still carrying on with everything we should be doing — some people are holding back on cap ex on buildings but we are not. The no-deal scenario creates uncertainty but it will only be short term, you have 27 countries with different agendas and some have strong trading links with the U.K. and they want a deal too. We think there will be a deal and the market thinks there will be a deal too.
“We are keeping gearing lower than it otherwise would be — it is currently 30%. In the previous downturn we had gearing of 70%. If you are at 50% or even 55%, you will be fine.
The value of certain property is still going up, certain types of very good investment property. Retail is going through a very difficult time but it will find a level. But it is not there yet. But it is like 2006, you are looking to buy and getting outbid, people are offering very high prices, often overseas investors who have benefitted from the fall in the value of Sterling. That is not helping the leasing side.
But Central London is completely different to the rest of the country. People in London aren’t listening to people in the North — outside of London people see Brexit as a positive. The letting market in Manchester is the best it's ever been, and it’s the same in Leeds. It’s totally different to the South.
If I do see a correlation with 2006 it is that the market is getting a bit frothy. Industrial in particular is a bit frothy, certain types of investment property are a bit frothy. We've seen things we’re looking at priced very fully, so you do have to be careful.”
Hear Partridge and a host of other industry luminaries discuss the prospects for London in 2019 and beyond at Bisnow's London State of the Market event at Twentytwo on 1 November.
