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U.K. Real Estate Losses May Be Biggest in 25 Years (Update1)

Jan. 7 (Bloomberg) -- LaSalle Investment Management put Condor House, a seven-story office building facing London's St. Paul's Cathedral, on the market for 130 million pounds ($256 million) six months ago. The building sold last month for about 117 million pounds, 10 percent below the asking price.

Appraisal values fell at a record rate in November and commercial real estate derivatives contracts indicate owners of British offices, shopping malls and warehouses may suffer their biggest annual losses in more than a quarter century.

``The U.K. market is falling apart,'' said Peter Hobbs, London-based head of research at RREEF Real Estate, a Deutsche Bank AG unit that manages about $100 billion. ``There's a risk that this cyclical downturn turns into something worse.''

Britain's 700 billion-pound commercial property market will perform worse in 2008 than the rest of Europe, the U.S. and Asia, Hobbs said. The slide is accelerating as banks tighten lending standards across the globe after losses of more than $90 billion from U.S. mortgage investments. Jones Lang LaSalle Inc., the world's second-largest commercial real estate broker, estimates transactions in the U.K. slumped 60 percent during the final quarter of 2007 to about 5 billion pounds.

Building owners may record losses of at least 11 percent in 2008, according to prices of derivatives contracts pegged to indexes compiled by London-based research firm Investment Property Databank Ltd.

The decline would be the largest since IPD introduced its annual total-return index in 1981, which combines data for rental incomes and changes to appraisal values. The benchmark index covers 200 billion pounds of investments and excludes debt, which can multiply property gains or losses.

`Element of Hysteria'

``There's an element of hysteria'' in the market, said William Hill, head of London-based Schroder Property Investment Management, which oversees 10 billion pounds. As funds are forced to sell buildings to meet investor redemptions, finding a buyer at a high enough price is like ``grasping an eel,'' he said.

Westfield Group, the world's largest mall-owner, canceled plans last week to sell the remaining 33 percent of the 530 million-pound U.K. Shopping Centre Fund. The fund owns 25 percent of the shopping centers in Belfast, Derby, Dudley and Tunbridge Wells.

British Land Co., the U.K.'s second-biggest real estate investment trust, abandoned efforts in October to sell a stake in Meadowhall Shopping Centre on the outskirts of Sheffield in northern England. It cut the value of the property by 79 million pounds to 1.58 billion pounds a month later.

Appraisers lowered commercial values by an unprecedented 4 percent in November, increasing the cumulative 11-month decline to 7.8 percent, IPD reported. In the last property crash, values dropped 27 percent from 1989 through 1993.

Canary Wharf

Most investors say this slump is different from the 1990s, when an economic recession, rising interest rates and oversupply from the previous decade's construction boom beset the market.

In the early 1990s, mounting debt and office vacancies led to the bankruptcies of companies including Paul Reichmann's Olympia & York Ltd., which began Canary Wharf. The business and retail district now contains the U.K.'s three tallest buildings: One Canada Square, HSBC Tower and the Citigroup Centre.

British Land bought the Broadgate development next to Liverpool Street railroad station in the City of London in 1996 after developer Rosehaugh Plc went bankrupt and partner Stanhope Properties Plc encountered financial difficulties.

Unlike the 1989-to-1992 period, demand from new tenants is ``robust and rental growth trends are positive across most markets,'' said Cliff Hawkins, who oversees UBS Asset Management's 2.38 billion-pound Triton Property Fund.

`More Shocking'

Commercial rents rose at an average monthly rate of 0.4 percent since the start of 2006, according to IPD, reflecting the health of the British economy. A shortage in supply has ensured London is the world's most expensive location in which to lease an office, agent CB Richard Ellis Inc. estimates.

The U.K. jobless rate is the lowest in more than 30 years and the Bank of England reduced its benchmark interest rate last month to 5.5 percent, half the average level of 1990 to 1992.

Values of shops, offices and warehouses peaked in the first half of last year after the agreement by Spain's Metrovacesa SA to buy HSBC Holding Plc's headquarters at Canary Wharf for a record 1.09 billion pounds in April.

British commercial property values last declined in 1995. This time, the slide is ``looking shorter, sharper and more shocking than even we had expected,'' said Mike Prew, a London- based analyst at Lehman Brothers Holdings Inc.

Real estate shares, the worst performers last year of 39 industry groups on the London Stock Exchange, trade at a 32 percent discount to net asset values, Prew said.

Fund Redemptions

New Star Asset Management Group Ltd. said Dec. 10 that the value of the properties in its flagship 1.7 billion-pound Property Unit Trust mutual fund dropped almost 18 percent since July. To keep pace, it will switch from monthly appraisals of values to ``at least twice a month until the property market returns to a more stable state.''

Falling values are spurring investors to pull out of real estate funds, forcing some to sell properties to meet redemptions. At least five U.K. funds have placed curbs on investor withdrawals.

Friends Provident Plc, the British insurer that's carrying out a strategic review of its operations, said last month that investors won't be able to withdraw savings from its property funds, giving it as much as another six months to sell buildings.

``There's been a step change since October,'' said Patrick Bushnell, head of European investment at Henderson Global Investors. ``People will expect a much sharper correction in the value of funds.''

Ripple Effect

Funds specialized in owning buildings incurred their first losses in more than 14 years in the third quarter and then, in October, property mutual funds suffered 158 million pounds of net outflows, the first in almost four years. A month later, redemptions increased to a net 495 million pounds.

``Further net outflows could result in funds being forced to liquidate assets, which could potentially spark a spiraling sell-off in the market,'' said Sally Collins, a senior adviser at Bestinvest, which counsels British savers with more than 2 billion pounds of investments.

Kingspan Group Plc, Europe's largest maker of flooring and insulation panels, said last month that 2008 will be ``more challenging'' because of the slowdown in the U.K., where it generates 60 percent of sales.

``The credit crunch has exacerbated the correction'' since June and ``it's happened quite quickly,'' said Michael Brodtman, head of U.K. valuations at CB Richard Ellis, the country's largest appraiser. ``People look at risk completely differently now.''

Bloodied Noses

Brodtman estimates capitalization rates, or rental income as a proportion of a building's value, rose by 75 basis points to 125 basis points in the second half of 2007. He declined to estimate how declines in building values will affect the rate this year.

IPD calculates that average U.K. capitalization rates were about 4.5 percent at the end of the first half. A basis point is 0.01 percentage point.

Shares of investment trusts and developers have already been hurt by concern that the companies will incur losses.

Capital & Regional Plc slumped 75 percent last year, making the London-based manager of real estate assets the U.K.'s worst- performing property stock. Its 27 percent stake in the 1.3 billion-pound Junction Fund, whose most valuable asset is the Thurrock retail park near London, fell almost 24 percent in the first 11 months of last year.

Financial District

Real estate investors still underestimate the economic slowdown caused by higher borrowing costs and banks' reluctance to lend, according to Martin Allen, an analyst at Morgan Stanley in London. He expects ``further significant falls'' for shares of U.K. property companies in 2008.

The credit crunch may cause financial-services companies in London to cut 6,500 jobs and reduce bonuses by 16 percent, according to data compiled by the London-based Centre for Economics and Business Research Ltd.

British Land has yet to find tenants for its Ropemaker and Leadenhall Building developments in London's main financial district, which are scheduled to be completed by 2011. The company's shares tumbled 45 percent in 2007, exceeding the average 39 percent decline for U.K. real estate stocks.

Derivatives pegged to IPD's total-return indexes indicate owning a commercial building may not become profitable until 2011, prices quoted by Tradition Financial Services showed.

`Common Sense'

Still, the U.K. may be too big for investors to shun for long. Britain accounts for a quarter of Europe's real estate investment market.

Raymond Mould, a 66-year-old real estate investor, raised 248 million pounds in November in an initial public offering of London & Stamford Property Ltd. to try to take advantage of lower prices.

It's the third company formed by Mould and his associates in the past 30 years. They raised a combined 1.09 billion pounds from the sale of Arlington Securities in 1989 and Pillar Property Plc in 2005.

ING REIM, which vies with RREEF as the world's largest real estate asset manager, plans a Global Opportunities Fund which ``may well look at the U.K. as a destination, whereas four months ago it would have been too expensive,'' said Robert Houston, chief executive officer of ING REIM's U.K. arm. ``Sentiment is playing an increasing amount in the pricing of assets. We are in danger of it overriding common sense.''

To contact the reporter on this story: Simon Packard in London at packard@bloomberg.net .

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