London’s Burning Question
Property Week

London’s Burning Question

The capital’s prime residential prices are creeping upwards and inexperienced developers are jumping on the bandwagon. Nick Johnstone asks if over-exuberance could cause an already red-hot market to overheat.

As the dust settles over Stratford post-Olympics, one London developer is seeking to break a rather different kind of record. Manhattan Loft Corporation founder Harry Handelsman’s sights are set on selling flats for £1,000/sq ft at Manhattan Loft Gardens — his latest residential scheme a few minutes’ walk from the Olympic Park. It is a confident appraisal: the price would dwarf the £450/sq ft local average and smash value records for that part of the capital.

“You think it’s expensive because nothing has been done before at this level, but my scheme is probably worth three or four times that much,” claims Handelsman. Only in central London’s red-hot residential market could such straight-faced optimism still exist today.

Research from Knight Frank published in June shows prices for prime residential have risen by 47.3% since March 2009 and Savills says land prices have risen in parallel.

Developers — from REITs to opportunity funds — believe soaring overseas demand and chronic undersupply make the capital an obvious port in the global economic storm. Last Friday, Australian developer Lend Lease became the latest to step up its exposure, pledging to develop 1,000 London homes a year by 2017.

So those who glimpsed Savills’s half-year results last Thursday were entitled to a sharp intake of breath. The agent reported a “general reduction in activity” in the sector, and that it was “too early to tell” if this was a short-term hiatus caused by the summer holidays and Olympic fever — or the start of something bigger.

Cool down
London’s residential boom is certainly showing some signs of cooling. Land Registry figures last month indicated that March’s stamp duty hike had prompted a 24% fall in sales of properties of more than £2m. Prime London prices might have increased by 5% this year, says Knight Frank, but zero price growth is expected between now and the end of 2013.

This makes uncomfortable reading for those pinning hopes on climbing values. The message from seasoned developers, such as Tony Pidgley, Gerald Ronson and Nick Candy, is summed up by Handelsman: “I’m bewildered how anyone thinks [London residential] is an easy way to make a quick return, and that every price is achievable — as though we are not in an economic crisis.”

The sector retains its allure, however, because of its seemingly bulletproof fundamentals. CBRE research shows the number of affluent households in central London is expected to increase by 51,000 in the next 15 years, outstripping forecast supply by 33,000 units.

Far Eastern demand also continues to grow, spurred on by exchange rates that promise generous yields of 5%-6%. Every week, three or four roadshows pass through Hong Kong and Singapore’s five-star hotels, offering discounted slices of prime London property. For the investors, who are mostly accustomed to new-build developments, buying an apartment before the scheme even exists is normal.

The Far East success of schemes such as Aviva Investors’ and Exemplar’s Fitzroy Place in the West End and Ballymore’s Embassy Gardens in Nine Elms is well documented and these off-plan sales, in turn, help to cement the case for cautious lenders. In anticipation of 2013’s Basel III regulations on holding equity against debt, banks often require the presale of a large proportion of flats before releasing funds to start work on site.

Agents insist prime central London is no one-trick pony, however, and that the variety of nationalities buying homes has doubled to around 50 or 60 since 2007, prompted by political and economic turmoil overseas. The underlying assumption is: “If my flat in Chelsea goes wrong, the whole world has gone wrong.” At best, the value will increase and, at worst, it remains a stable investment.

But there are mounting concerns that the need for speedy presales is prompting some developers to offer discounts, and further worries about less-established developers distorting prices in more peripheral locations.

Brochures for a scheme in Whitechapel, east London, which was recently promoted at Hong Kong’s Mandarin Oriental hotel, claim the area is “now classified as prime central London”. Another in nearby Poplar boasts panoramic views of the “whole Olympic site”. Both are in the borough of Tower Hamlets, one of the most deprived in the country.

So the imagination and savvy of Far Eastern buyers are increasingly being tested. One agent suggested the Far East was being offered a “jumble of product”, and claimed smaller developers had also jumped on the bandwagon.

Berkeley Group chairman Tony Pidgley says the mood among developers is “over-exuberant”. “People think that wherever you are, as long as it’s got a London postcode, you can sell it abroad. But if you price your product wrong, you won’t.”

Ever the optimists
Residential developers are increasingly talking about overpriced land deals based on the most optimistic price projections. Whether or not these make a profit depends not only on the location, but also the micro-location and the quality of the flats.

This explains Handelsman’s boldness in Stratford. His scheme is sandwiched between Westfield’s Stratford City shopping centre and Stratford International interchange. Next door to his Bankside Lofts scheme, which was developed 15 years ago on the south bank of the Thames, Native Land is now selling flats at Neo Bankside for £1m and more.

London’s big residential developers believe non-specialists will struggle to understand the nuances involved in such projects. Candy & Candy co-founder Nick Candy, who managed the development of One Hyde Park in Knightsbridge, explains: “A lot of them are working on models that rely on growth in the next two years.

If you think it’s the same spend as on a commercial building, you’ll have stock that’s unsellable or you’ll make a loss.”

Frogmore founder Paul White says he is concerned about the number of new entrants to the market, particularly those that are more accustomed to developing office parks than flats.

“If you’re building 100,000 sq ft of offices, you need three or four lettings. With residential, you need to do 100 deals.”

Non-traditional developers of London residential have increased, among them Orion Capital Managers, Carlyle Group, British Land, and London & Stamford Property. Meanwhile, Far Eastern investors have been buying entire sites, such as the £250m St John’s Wood Barracks and the £400m Battersea Power Station.

However, there are important distinctions to draw between different areas of the market, particularly between super-prime homes for the super-rich and volume building for Far Eastern or domestic buyers elsewhere. Savills research shows that the number of new super-prime units of £5m-plus will double in 2014 (table, below and map, above). But it predicts there is sufficient demand.

Almacantar chief executive Mike Hussey, who has submitted plans to develop high-end residential in Centre Point on Tottenham Court Road, says people will always pay for a unique product. He adds that around 1,000 private units a year are granted planning consent in the West End and contrasts this with estimated demand of around 7,000 units. Indeed, there will always be a “scarcity premium” on the most expensive properties, such as One Hyde Park or the flats at the top of London Bridge’s Shard.

Yet when developers bring 300 units of the same product to the market at once, the romance fades, particularly if developers need to charge £1,000-£1,500/sq ft to justify land price and build cost. As Candy, who was involved in Qatari Diar’s £960m purchase of Chelsea Barracks in April 2007, says: “It is not an easily scalable business.”

Hussey adds: “If you’re doing 300 units on the South Bank in one hit, you need to be a Berkeley Homes, which knows about the product mix and is set up with the required large marketing teams.

If commercial developers start departing from their norm without changing their set-up, they will get burnt.”

Too hot to handle
Savills’ latest research into housing supply says sales volumes in 2013 are 50% more reliant on large schemes than the “very strong” sales year of 2011. It warns that there are limits to the volumes of demand, particularly on central London’s fringes where many of these schemes are located. No wonder prices are expected to plateau next year.

One senior UK banker, who did not wish to be named, says he is being offered overpriced land deals in this “volume” part of the market: “I get a bit worried sometimes. Part of me is concerned about it getting too fashionable and overheating.”

Mount Anvil chief executive Killian Hurley is more candid still: “It’s like death — it’s not ‘if’, it’s when. The market is very hot and there are too many people chasing sites. It’s putting up land values, and people are not remembering the lessons of history.”

Others, among them Native Land chief executive Alasdair Nicholls, view the environment as less volatile, and point to a process of natural selection in which only the best developers are being offered enough equity and debt to buy land.

But as long as commercial property remains in the doldrums, London residential will keep its rose-tinted glow for many investors.

Heron International chief executive Gerald Ronson says: “Nobody’s got a crystal ball to predict what price they’ll get for flats in three or four years’ time. The agents are talking up all this stuff and people are getting suckered into things but, for many overseas investors, the yield is irrelevant. People don’t trust banks, and wealth protection is very important in the world we live in.”

Those more concerned with chasing returns should be wary, however. Ronson identifies Nine Elms, where there is planning consent for 10,000 homes, as an example of potential future oversupply. At Battersea Power Station, the first phase alone is as big as Berkeley’s Imperial Wharf across the Thames. That scheme has sold 100 units a year, so it could be 35 years before Battersea’s new Malaysian owners have shifted all their flats.

London’s supply-demand dynamics are here to stay. But the message from the capital’s most experienced developers is loud and clear: proceed with caution.

What the industry is saying 

Tony Pidgley, Chairman, Berkeley Group
Everybody thinks London is now a panacea for the world. In the right place with the right product it will sell . Is it as bad as HBOS? No. Are people overpaying around the edges? Yes. I do believe the Olympics was a signal that we’re here to do business, we’re organised and in a democracy. But I think people believe that wherever you are that’s got a London postcode, you can sell it abroad. We’ve had a flight to residential, but if you price your product wrong, you won’t sell it. There is over exuberance going on here. Not everyone can become Native Land overnight. Is London safe? It is as safe as ever. But will people get hurt buying land? Yes.

Neil Batty, Head of Knight Frank International Sales
There’s a jumble of product being taken out to the Far East, and three to four exhibitions a week. Smaller developers have jumped on the bandwagon. We’ve also seen fringe product that hasn’t gone as well. Everyone’s going to Asia because everyone’s talking about Asia, but they only want zone 1 quality product that performs. Most of the buyers know the location, or can send family or friends there.

We price a project based on professional valuation advice – not on it selling in Asia. Buyers are no different in Asia.

Gerald Ronson, Chief Executive, Heron International
Obviously residential is a hot market and a lot of sites are talked up in terms of value. It appeared to get overheated over the last six months, but there has been a new normality over the Olympics. The market has definitely slowed since the budget. Nobody’s got a crystal ball to predict what price they’ll get for flats in three or four years time. Provided this government doesn’t do anything too stupid and stop foreigners from coming over here, London will remain strong. For many overseas investors, it’s irrelevant what yield you’re getting, and wealth production is very important in the world we live in. If it’s in a bank and unsecured, then who knows? Whereas if you want to park £400m like they did at Battersea Power Station, then things have a way of working themselves out over time. We’re a bit long in the tooth to do that ourselves.

Mike Hussey, Chief Executive, Almacantar
There is no one simple layer in central London residential. In the super-prime world, people will continue to pay for a unique product either by location or specification.

The magic of property is that there is a limited supply of land and there is development control, so in some areas, like the West End, the supply demand balance will ensure units will always sell .

If there are 3m sq ft of consents likely to be delivered in the next five to six years – that’s 500,000 sq ft gross each year and 400,000 sq ft net. So on average, 400 units of 1,000 sq ft each a year. By contrast, we understand there are 7,000 units of demand in the West End.

It is at value less than £1,500 / ft where there is more supply and a larger competing pool, in areas such as Nine Elms and along the South Bank.

If you are doing 300 units plus on the South Bank in one hit, you need to be a Berkeley Homes, who know about the product mix and are set up with the large marketing teams required to target these buyers. The quality volume game is for the specialists. If commercial developers start departing from their “norm” without changing their own set up, they will get burnt.

Alasdair Nicholls, Chief Executive, Native Land
We’re living in a city with a fundamental mismatch between supply and demand. Any development stands or falls on the quality of the land purchase. Developers should make sure they’ve bought land well so they can deal with whatever fluctuations occur in the market. Agents are pushing land values based on prices at the top end of the scale. But deals are taking time and common sense usually works its way in.

Harry Handelsman, Chief Executive, Manhattan Loft Corporation
If you know what you’re doing, it’s exciting, but if you lose the element of professionalism and expertise and see it as a way to make a quick return, it’s not good. People think it’s an easy opportunity but you need to make sure you know what you’re doing. I’m bewildered that everyone thinks every price is achievable as though we’re not in an economic crisis – will the bubble burst in the Far East? I’m very optimistic about our scheme in Stratford – we’re going to see how the dust settles after the Olympics, but people want quality.

David Thomas, Group Finace Director, Barratt
We’ve been in the London market for 20 years, and see it as very attractive. There isn’t a firming in the market that means we can’t participate. It’s difficult to predict prices – we don’t assume any price growth. The number of people bidding is bigger now than it was two years ago, but the supply-demand dynamics will remain strong because of population growth.

Killian Hurley, Chief Executive, Mount Anvil
These things go in cycles. When it goes up too quickly, it generally comes down. The market is very hot and there are too many people chasing sites. It’s putting up land values and it’s stupid. We don’t have to buy any sites. Housebuilders have to have volume and have to keep buying. People forget that residential development is very risky. They bid 20-25% higher than us, so they’re taking a view that house prices will keep rising. It’s like death, it’s not if, it’s ‘when’. My advice is to proceed very cautiously. People are not remembering the lessons of history, and they’ll have to live them again in the future.

Nick Candy, Co-Founder, Candy & Candy
Too many commercial buildings being bought to convert to residential. It’s not a scalable business – Tony Pidgley and I have both found that out.

Time will tell but a lot of them are working on models that rely on growth in the next two years that is not sustainable. If you think it’s the same spend as a commercial building you’ll have stock that’s unsellable or you’ll make a loss. It’s the second rate stuff that doesn’t sell. I don’t think prices will move over the next three years.

Paul White, Chief Executive, Frogmore
The lack of development finance means the gap is being filled by private equity-type funders. It’s one thing being a great developer of office parks, office buildings, industrial parks, etc, but developing residential is a different thing. I get nervous when non-specialists start coming in, with no track record. If you’re building 100,000 sq ft of offices, you may need 3 or 4 lettings, but with residential you may need to sell 100’s of units. It’s a whole different skill set. The market is buoyant right now, but the residential development market can soon overheat when there is too much of it going on. Although we are far from there right now.