Risk is perceived in terms of security of capital, security of expected income and liquidity. There is systematic risk which affects all investments, such as: economic cycles, interest rate fluctuations, this cannot be diversified away. Non-systematic risk is investment specific and for property this includes: tenant risk, sector and geographical risk, structural risk, legal risk and planning. An encouraging factor in the past for increased investment in property was availability of credit. This has now been greatly constricted, making it difficult for developers to find investors to fund a new build.
This issue may mean there will be a lack of new offices in 2010. This can lead to an undersupply in the market greatly inflating rents. Speculative development could become a real issue by disencouraging tenant occupation in London due to rental values being too high. Another risk is the departure of foreign investment; this would be an issue because it is accountable for much of the demand for office investment in London. Foreign investment has increased due to the reduction in the value of the pound and the reduction in prices for property.
This is a very likely risk as the pound will eventually increase in value making investment in the UK less appealing to foreign investors. This risk can be mitigated by UK institutions being the predominate supplier in investment reducing reliance on foreign investors. As mentioned by Harris, 2005, technology has been a large factor towards the office sector. It has led to greater requirements of offices for flexible businesses. Improved information technology could soon make location less relevant to businesses. Over the past two years marker rental values have dropped and many leases are upward only meaning many leases are now over-rented.
This may mean many tenants could default on rent or use the break clause. This would be a huge effect on the office sector and reduce investor confidence by tenants being of higher risk than before from difficulty to pay rent. This would make this asset class less attractive compared to gilts, bonds, stock market etc. Deflation could occur, which would make paying rent difficult for tenants and investors would find credit difficult to pay back. The quality of this investment class would not be competitive and GILTS would be safer and greater return option.
Sector and geographical risk: ‘Lumpiness’ of property investment accentuates this type of risk; International diversification can ameliorate some of this type of risk. Tenant risk: Non-payment of rent or other contractual obligations Structural risk: quality of build Conclusions and Recommendations To conclude on the sector itself, recent reports on outcome suggest the sector is stabilising. As referenced before the sector is highly volatile towards economic cycles. And elements such as FTSE100 and residential prices increasing tell us the UK economy is coming out of recession.
This being the case, it will mean great positives towards the office sector, such as being safer investment, stronger tenant covenants, capital and rental growth. Recommendation would be to see the outcome of 2Q1 2010 reports to fully determine whether the UK economy is out of recession. If it is the office sector would be give high turnover due to its volatility of economic boom. To conclude on London as a geographical location, from previous market trends this is the best location in terms of investment for commercial offices.
It far outweighs all other cities in the UK in terms of the amount of transactions and the growth patterns. The literature states the reasons for why London is the most successful city in the UK is in terms of commercial office investment from these factors; transport, central government, bank of England, headquarters for media etc. These factors are both appealing to the occupiers and investors; even though office rents are considerably higher the amount is acceptable due to the above factors.
Many tenants are willing to pay high rent and this means greater returns for investors. The first recommendation is to invest in London for commercial offices – it has high returns, a wide variety of tenants and it’s a safer investment compared to other cities. The next conclusion is focusing on whether to invest in a second hand property or a new development. From what the reports have predicted they suggest the current empty second hand offices will be taken up very quickly within the next two years due to high demand from a growing economy.
Because the current market is still oversupplied this tells us then that investment into development of new offices should only be done unless the build will be completed in mid to late 2011. Thus recommendation would be to invest once 2010 Q1 report suggests UK is out of recession and invest in a new development to be completed by start of 2011. This is because many tenants will be looking for new offices and there will be very little on the market. This can give a high value to a new build from a lack of supply, and tenant specialist requirements.