#exporeal Conditions in London ripe for 'sudden downturn', experts warn

London has been a magnet for investors for many years now and continues to attract foreign players, but conditions are ripe for a sudden downturn which could materialise next year, experts warned during a special Investment Forum at Expo Real on Wednesday.

‘There are still large amounts of capital targeting central London, and this year is still a good year with returns of 20%, but the risks are building up,’ said Simon Wallace, head of research for Europe at Deutsche Alternative Asset Management. ‘The downturn could be sudden and capital values could fall by 20-30% very quickly. I think now is a good time to exit the market.’

Johannes Haug, senior vice-president and global head of acquisitions at Pembroke Real Estate, agreed: ‘We are bracing ourselves for a correction, even if the facts do not point to an immediate downturn, and there are deals still happening at astonishing prices. But it has been a long run, we are six-seven years into the cycle, so it definitely is a time to be cautious.’

Foreign capital, which now accounts for 60% of investments in London, shows no sign of losing interest. ‘In the first six months of the year, London has attracted more capital than the other top 7 European cities put together,’ said Simon Mallinson, executive managing director for EMEA at Real Capital Analytics. ‘There is a constant flow of foreign investors who are new to the UK market or to real estate and who want London in their allocation as a starting-point, at whatever price.’

Development returns, shifting demand/supply balance
Looking at offices in central London, the situation looks ideal: rents are rising, vacancy rates are at record low levels and capital is still flowing in, but the seeds of change have already been sown. ‘Demand is still high but supply is increasing,’ said Wallace. ‘It is not just the shiny new buildings, there is a lot of refurbishment going on. I believe the return of development will slowly but surely shift the demand/supply balance, possibly triggering the downturn.’

Another potential trigger could be the so-called ‘Brexit’ referendum on leaving the European Union which prime minister David Cameron has promised to hold before 2017, but which is likely to happen sometime next year. ‘If there is a Brexit the big hit will be in central London, and offices will see the worst impact, while retail and logistics will be relatively unscathed,’ said Wallace. ‘Our rent growth projections will be 25% lower in case of the UK leaving the EU.’

The market does not seem to have focused much on the risks of Brexit because no date has been set for the referendum yet. Last year in Scotland the first effects of the impending referendum on the real estate market were only felt a few months before the vote, when it suddenly became real, and the same thing is likely to happen for the EU referendum. ‘The real estate industry likes to ignore political risk until it cannot possibly avoid it,’ said Charles Balch, managing director and head of real estate finance at Deutsche Pfandbriefbank. The sun is still shining, but London’s long-held safe haven status looks a little shakier now.