Andrew Baum and David Hartzell, Global Property Investment, 2011Andrew Baum and David Hartzell, Global Property Investment, 2011
The L&G case: London office purchase 1992 / 2006
Andrew Baum and David Hartzell, Global Property Investment, 2011
Case study
London office sale by UK insurance company, 1992 1990 development 1991 25 year lease with 5-yearly reviews to market rents, upward only Let to partnership of lawyers End 1992: lease rent £760,000 (£50psf); market rent £296,000 - £370,000
(£20-25psf) January 1993 sale – at what price?
Andrew Baum and David Hartzell, Global Property Investment, 2011Andrew Baum and David Hartzell, Global Property Investment, 2011
Why the UK won’t join the Euro - yet
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal issues: the UK view
• Interest rates raised from 10 to 15 per cent • UK formal decision to quit ERM, rate rise reversed• In two days, $30 billion sold from UK reserves• £ set to slide in value• Gilt and interest rates set to fall
• Canary Wharf bust • Sunday newspapers full of ‘negative equity’• No office tenants!
Andrew Baum and David Hartzell, Global Property Investment, 2011Andrew Baum and David Hartzell, Global Property Investment, 2011
Sterling/$, 1985-1993 – Black Wednesday
Andrew Baum and David Hartzell, Global Property Investment, 2011
Rental values and growth 1988-1993 - collapsing
-20
-10
0
10
20
30
40
50
60
70
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Source: IPD, PFR 2006
Lease signed
Sale date
… and these are appraised values…
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal 1: Summary
Cash flow (fixed) £760,000
Term: 23 years
Long gilt: 8.4%
Risk premium: ?%
Required return: ?%
Value: £?m
Andrew Baum and David Hartzell, Global Property Investment, 2011
Valuation: December 1992
Term:Rent passing £760,000PV pa, 23 years @ 10.00% 8.88Capital value £6,751,246Reversion:ERV £370,125PV pa, perp @ 10.00% 10PV, 23 years@ 10.00% 0.11Capital value £413,349Valuation £7,164,595
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal issues: the UK view
• Cash flow– Rental value?– Rental growth forecasts?– Rental growth net of depreciation
• Discount rate– Risk of default – Rental value protection? – Risk premium over gilts?
• Exit price• Holding period return?
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal 2: Summary
Long gilt: 8.4%
Risk premium: 2.0%
Required return: 10.4%
Value: £7.8m
Andrew Baum and David Hartzell, Global Property Investment, 2011
The German view: five key points
• The cash flow is effectively fixed for 23 years – there is no upside but also no risk
• The local risk free rate is lower so the discount rate, all things being equal, could be lower than a UK buyer’s
• Default risk is tiny, the currency looks as if it has fallen a long way already and the buyer has a long term perspective – so illiquidity is unimportant and the risk could be seen to be low
• Germany is a low return market, so this asset might add a lot to the fund’s returns
• UK property – this is a new building in the City - looks cheap compared to recent prices especially after the £ collapse
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal 3: the German view
Long gilt: 6.9%
Risk premium: 2.0%
Required return: 8.9%
Value: £8.9m
Andrew Baum and David Hartzell, Global Property Investment, 2011Andrew Baum and David Hartzell, Global Property Investment, 2011
Sterling/DM, 1992-2001
Andrew Baum and David Hartzell, Global Property Investment, 2011
The outcome
• Property bought for £8m• Property sold 2001 for £12.5m with 15 years remaining;
ERV now £40psf• Running yield 9.25%• German market returns 5% every year • IRR 13.1% in local currency • IRR 17.5% in DM• ERV in 2003: £25psf?
Andrew Baum and David Hartzell, Global Property Investment, 2011
2006
• The same property is now on the market again. The 2001 buyer is making the most of recent price rises and cashing in
• Rental values have recovered in the City but the property is now 15 years old with exactly 10 years to run on its lease
• The lawyers want to vacate the property but remain liable for the rent
• What is it now worth?
Andrew Baum and David Hartzell, Global Property Investment, 2011
Source: IPD, Datastream 2006
Property and gilt yields appear related…
4
5
6
7
8
9
10
11
12
(%) 10 year gilt yield Property equivalent yield
Andrew Baum and David Hartzell, Global Property Investment, 2011
2006
• Bidders include three sub-groups– a German open–ended fund– a private equity (opportunity) fund– a UK pension fund
• What price will be paid?• Which buyer type will win?
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal 4: summary
Net exit value £5,980,559
Base value £5,503,736
Froth value £705,291
Total value £12,189,585
Andrew Baum and David Hartzell, Global Property Investment, 2011
Appraisal 4
Annual rent 760,000 Long gilt 4.50%
Annual ERV psf 37.50
Total ERV 555,188 Base prem 1.50%
Inflation 2.50% Froth prem 2.50%
Prop prem 2.50%
Growth real nominal
Growth 1 10.00% 12.75% Reqd ret qtrly annual
Growth 2 5.00% 7.62% Base 1.47% 6.00%
Growth 3 0.00% 2.50% Froth 1.71% 7.00%
Growth 4 0.00% 2.50% Prop 1.71% 7.00%
Growth 5 0.00% 2.50%
Growth long 1.00% 3.53% Net exit value 5,980,559
Base value 5,503,736
Depreciation pa 1.50% Froth value 705,291
Depreciation pq 0.37%
Exit yield 6.00%
Review costs 2.50% Total value 12,189,585
Andrew Baum and David Hartzell, Global Property Investment, 2011
Performance 2001-6
Year end Capital Costs Rent Net cash flow2001 -£12,500,000 -£593,750 -£13,093,7502002 £760,000 £760,0002003 £760,000 £760,0002004 £760,000 £760,0002005 £760,000 £760,0002006 £12,190,000 -£213,325 £760,000 £12,736,675
IRR 4.237%Running yield 5.804%Capital gain -£1,117,075
Andrew Baum and David Hartzell, Global Property Investment, 2011
Where will the highest bid come from?
• German open–ended fund? – risk free rate advantage?– Germany and its relative attractions– UK property cheap? – currency advantage?
• UK pension fund – appealing in 2006?• Private equity (opportunity) fund: options?
Andrew Baum and David Hartzell, Global Property Investment, 2011
Private equity (opportunity) fund: options
• Gear highly and boost IRR on equity• Obtain possession, get payment from law firm
– develop if profitable– if not profitable, take rent and wait until it is
• Worst case: no profit in immediate development: collect 6% + income yield, geared if profitable, and wait
• Re-negotiate lease with tenant: surrender and renewal for 15 years at a lower rent, sell to UK pension fund at 4.5% cap rate
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