Although many institutions have reduced their exposure to direct property investment, others have taken the opposite view, particularly on speculative developments in the major provincial cities.
When George Soros, the international financier, suddenly terminated his joint venture property investment vehicle at the tail end of 1994, it sent a shiver through the industry. Just 18 months earlier, when the investment market was buzzing with deals and capital values were climbing virtually by the month, Soros had linked up with British Land to spend £1 billion on property for 10 years. Soros had built his reputation through an uncanny knack of reading markets correctly and for his willingness to back his judgments with billions. But last November after spending £600 million, the tie-up was wound up just as suddenly as it had been announced. 'We consider that more attractive long-term opportunities have opened up since the joint venture was formed,' said Soros.
It was a bitter blow for the property industry. Despite rumours that Soros is nursing big losses from the turbulent currency and bond markets, he is an astute investor and knows a good deal when he sees one. Property, he decided, was not one of them. For a man who had made a £1 billion profit from short-selling sterling in the run-up to its exit from the exchange-rate mechanism in September 1992, property was never going suit Soros's temperament or match his hunger for spectacular profits. Privately he is understood to have told British Land's chairman, John Ritblat: 'I need gains of 40-50% a year.' It was an impossible target for the fund to reach.
Few question Soros's short-term assessment of commercial property returns. The same opinion was heard in the boardrooms of some of Britain's biggest institutions at the beginning of this year when they carried out their annual review to determine asset allocations within their portfolios. Many endorse the view that the short-term picture is one of slow performance, relying on rents starting to climb in the office, retail and industrial sectors, before there can be a sustained return to capital growth. Property analysts say their investments will become increasingly selective, looking to Britain's major cities like Leeds, Manchester, Bristol and Birmingham, where the supply of new space is short. Many companies, which had put their plans to relocate out of London on hold during the recession, are now dusting them down again.
Some have decided to bail out of the property sector, maintaining that the rewards are unsufficient. Scottish Equitable, the life assurance company, with £8.5 billion under management, decided in June 1994 to withdraw from commercial property investment, and is in the process of selling its £250 million portfolio. 'Our research suggests a very substantial underperformance of property over the longer term,' said company secretary Roy Patrick at the time. Other funds, such as Royal Insurance and PosTel, have also weeded out parts of their portfolio which they believe to be either unprofitable or too management-intensive. Last year Royal sold 167 properties, totalling 1.8 million sq.ft, to British Land for £128 million. Royal had owned the portfolio since the 1970s but its illiquidity made it inappropriate for a general insurance fund and it wanted to reinvest the money in equities.
PosTel, which in December launched an 11th-hour, £250-million rescue plan for the beleaguered Stanhope Properties, has taken a similar view on the management of smaller assets. It believes it is better suited to a property company than a pension fund. Recently it sold a £143 million portfolio to Hammerson in exchange for shares.
'This is a way of staying exposed to the property market while the cycle is still positive, while enjoying the benefits of a more entrepreneurial management,' said PosTel's chief executive, Alastair Ross Goobey.
Andrew Walker, head of research and consultancy at Erdman Lewis, says, 'Institutional investors are divided in their opinions of property. The insurance companies are reacting to increased regulation and a change in the products that they are selling, which in turn requires a change in the types of assets required, while the pension funds are reacting to the proposed solvency ratios issued by the 1994 Goode report'.
alker adds: 'On the one hand, the economy is probably growing faster than is sustainable, implying a rise in inflation, and institutions have taken advantage of the long-term relative attractiveness of property. On the other hand, some institutions, having a regard to a change in the match between assets and liabilities, prefer risk-free returns and therefore an increase in government bonds.' But they are not all selling: funds such as the Prudential, Scottish Amicable, AMP - the Australian insurance giant - and Legal & General have been highly aggressive, collectively spending more than £1 billion over the past two years, although they are now showing signs of slowing down and switching to other asset classes. Surprises, however, can occur when institutions believe there is a one-off opportunity. Friends Provident, the life and pensions group, stunned the market in December, when it forked out more than £100 million to buy a 75% stake in London Capital Holdings, the property investment arm of Citibank, the American investment bank. The fund is to take management control of an 800,000 sq.ft portfolio of office buildings and shops in London's West End.The initial yield is below 8%, but with an impending shortage of quality space in the area, analysts believe it could prove good value over the longer term. The Prudential is known to be scouring the London market to buy a prestige building for anything up to £100 million, but it is finding it difficult to find one at the right price. The best bargains were taken up during 1993, such as the acquisition made by Scottish Amicable when it bought the 266,000 sq.ft Chase Manhattan-occupied Woolgate House office building in the City of London, for £87 million. David Hunter, property director at Scottish Amicable and one of the leading lights in the industry, said he was attracted by the long-term development prospects offered by the site. 'Opportunities to buy freehold properties of this size and quality are scarce,' he said at the time.
Andy Gulliford, managing partner at Healey & Baker, the property consultancy, says: 'The property investment market is in a delicate state. We have reached a crossroads where yields have clearly fallen far enough and the great motor for property investment performance, rental growth, has not yet shown through.' He is cautiously optimistic and believes the picture has to be seen within the context of returns from equities and gilts. 'We are now in a period of low expectations of total returns from all investments and therefore lower yields on property are justified, particularly as there is clear economic recovery which should show through into increased tenant demand across all sectors.' Although he adds: 'Sceptics will say that lower property yields are not justified particularly when there is seemingly a trend towards higher interest rates and the demand for space - whether it is shop, office or industrial property - is just not there'.
Yet although institutions may be reassessing their attitudes to direct property investment, some are becoming attracted once again to the higher returns available in funding development projects. During the 1980s, the role of domestic institutions was overshadowed by the dramatic surge in bank lending and investment from overseas. The banks are still nursing large losses to property companies on their corporate loan books and are reluctant to return to the sector. Overseas investors like the Swedes and the Japanese are still having to wrestle with UK properties they acquired at the height of the 1980s boom. It has been left to the more bullish institutions to fill the vacancy left by the banks.
A few like Scottish Amicable, which has tied up a number of deals with Helical Bar, a quoted property company, and AMP Asset Management are meeting the challenge and believe it will pay dividends. John Whalley, director of property investments at AMP, explains: 'You certainly needed a very convincing story in 1993 to persuade directors to back speculative property development. Understandably, due to the previous three years' experience, there was inevitable caution. However, we had a very good story to tell in terms of future prospects and succeeded in placing substantial money into the market at just the right point in the cycle.'
The biggest commitment AMP has made so far has been to fund the £80 million office redevelopment of Woolhouse in St James's, in London's West End. The project has no occupier tied up yet but West End property experts believe Whalley has backed a winner. 'There have been very few speculative developments in central London in the last three years at a time when availability of prime buildings is shrinking,' says one West End agent.
But many see the biggest opportunities in the provinces, funding speculative developments to meet the shortage of office buildings in nearly all of Britain's big cities. National Mutual Life Assurance is one fund to have followed this route, buying a 6.8 acre site at Trinity Park near Solihull from Birmingham Airport Developments, a joint company set up by Birmingham International Airport and Burton Property Trust. The site has planning consent for up to 230,000 sq.ft of office space and its advisers are confident of attracting tenants quickly. Mike Tomkinson of Hillier Parker, one of the letting agents, says: 'This is undoubtably a significant boost for an area with little supply and, being so well located next to Birmingham Airport, we are confident that we will attract significant pre-letting interest.' Many of these funds are hoping to attract potential occupiers who are moving out of London. The scale of decentralisation slowed down in 1992-3 but, according to a recent survey of decentralisation of offices from central London by Jones Lang Wooton, rose sharply in 1994 with 19 major moves from central London involving a total of 8,440 jobs, mainly from the public sector. Over the past three decades London has lost almost 200,000 office jobs because of companies moving out to the regions.
Short-term funds may be holding back from property, but Phillip Nelson at Nelson Bakewell says the long-term attractions cannot be ignored. Historically, he says, it offers positive real returns between 4.5% to 5.5% and income growth has over the past 30 years always been positive and has matched inflation. Likewise, he argues, it has a good risk/return profile against other investments but says the property industry must continue the efforts it is making to promote itself better to pension funds. 'The amount of subjective judgment which is involved in asset allocation needs to be reduced by improving data reliability and the analytical techniques used by the property industry.' Even then, property is unlikely to hook the imagination of the Soroses of the investing world, but smaller squibs could well catch the habit.