Islamic Finance News – UK Real Estate: The Sweet Spot

In the media

The UK property market remains one of the few bright spots in its troubled economy, and according to sources at the Islamic Finance news 2013 Europe Forum last week Islamic investment in the sector continues to go from strength to strength. With new landmark deals appearing on a regular basis and accessibility improving through mutual funds and capital market instruments, the UK and Islamic investors are building themselves a mutually lucrative relationship that looks set to endure.

A recent survey of Islamic finance practitioners found that 54% thought Western real estate was important for the industry. Islamic investment into the UK has grown steady in recent years: buoyed by strong market performance, exacerbated by an aversion to debt-ridden European markets and supported by attractive government policies and a robust legal and tax framework. UK property firm Savills identifies growing interest from Middle East investors, while in its most recent report on ‘Emerging Trends in Real Estate 2013’ Ernst & Young notes that Asian capital is also flowing in.

The UK accounted for GBP30 billion (US$45.77 billion) of global real estate volumes traded in 2011, and according to Jones Lang LaSalle it remained the most active market in 2012, with crossborder investment playing an increasingly critical role. This is particularly true in central London, where foreign investment reportedly accounted for 85% of total cross-border activity in 2010 and 2011, and Jones Lang LaSalle confirms that: “The London market is stronger and more resilient than anywhere else.”

A good few years

The last few years have seen several landmark transactions come to market which have raised the profile of the sector to the point where interest may have reached tipping point. The two most famous Shariah compliant investments have of course been the The Shard skyscraper in London and the US$2.4 billion Ijarah purchase of the Chelsea Barracks (the highest-value UK land acquisition in history) — both by Qatar sovereign wealth fund Qatari Diar, whose other UK assets include Harrods and a share in the Olympic Village.

Other major transactions include the US$406 million Kings Reach Tower scheme in London by CIT Group, funded by a group of banks including ABC International Bank in September 2012, and GBP90 million (US$137.4 million) in funding secured by Islamic property firm 90 North over five years for Islamic investments including the acquisition of L’Oreal’s UK Logistics headquarters.

UK property developers have recognized the appeal of Middle Eastern funds and are now taking steps to market directly to this investor pool. In April of this year for example, an exhibition of luxury UK property was held in Dubai by property agency Hamptons International featuring high-end London properties some of which were exclusively available to Dubai investors and not even released to the UK market.

“Over the last 12 months, we have seen a steady increase in Middle Eastern investment across prime areas of London and the UK,” said Andrew Phillips, UK regional director at Hamptons, in a recent interview. Property consultant Knight Frank estimates that last year Middle Eastern buyers spent 50% more on London property than in 2011, buoyed by favorable currency exchange rates as the pound sterling weakened in comparison to the US dollar.

Big name banks

Powering the market are two of the UK’s best-known Islamic banks: Gatehouse and Bank of London and The Middle East (BLME), both of which have a significant focus on the real estate sector. In 2011 BLME won the Islamic Finance news Real Estate Deal of the Year for its financing of Dorchester town center regeneration project Brewery Square; and in 2012 it continued its investment strategy with a number of deals including a GBP13.5 million (US$20.6 million) three-year financing facility with London-based developer Aitch Group for the residential development of the Textile Building in Shoreditch.

The bank is also innovating in the financing field. Last year it signed a three-year revolving Murabahah financing agreement with Masthaven Property Finance to fund Masthaven’s bridge and short-term property finance business. Massoud Janekeh, the head of Islamic capital markets at BLME, commented that: “We have found that many businesses in the UK, and particularly in the property sector, are increasingly looking for partners that can offer a stable funding platform. To my knowledge this is the first time that a facility like this has been provided by an Islamic bank.”

Gatehouse has also made no secret of its focus on the real estate sector in the UK, with assets under management approaching US$1.5 billion. According to its 2012 results released last month: “Income has been driven by an active real estate strategy” and last year the bank made seven new acquisitions (five in the UK and two in the US) as well as two successful disposals. In October the bank completed a GBP165 million (US$251.7 million) acquisition of London property 10 Queen’s Street Place in collaboration with a Malaysian sovereign wealth fund, and this week it announced plans to invest GBP2 billion (US$3.05 billion) in real estate acquisitions in 2013.

A broad appeal

The UK offers a number of attractions for Islamic property investors, topping the list of which is the appeal of diversification into bricks and mortar assets in a secure and relatively strong economy. A UK-based accountant notes that: “Currency diversification, low political risk and strong economies are all reasons for Islamic investment into UK property”, while a lawyer cited “a strong revenue stream and a good return on capital”.

However, the UK also offers good governance and a strong legal and financial system with access to a pool of financial and legal experts which provides a sense of security. The UK government has also identified its goal of encouraging Islamic finance in the country, with the creation in January of the Islamic Finance Task Force to encourage more inward investment from the Islamic world.

Ease of access

And to this end, the market is widening and deepening with new avenues opening up to give investors access to the market. As well as the major institutional and commercial real estate transactions and direct investment into the residential markets, the fund sector is also performing well. UK-based asset manager London Central Portfolio (LCP) recently launched a Shariah compliant residential London property fund aimed at both domestic and overseas investors targeting returns of 10-13% per year and with the added attraction of no capital gains tax for overseas investors. “Our new fund will offer institutional and private investors access to a professionally managed and diversified portfolio in all of the recognized postcodes,” said CEO Naomi Heaton.

And as investor interest grows, new instruments are being introduced. In January this year Gatehouse launched its first real estate-backed Sukuk, giving investors a return based on the lease income of a 62,000sf property in Basingstoke in the Southeast of England currently leased to Fujitsu Services for a 68-year contract. The strong tenant profile encouraged confidence in the security of the investment, while the regular rental income gave reassurance as to the consistency of the returns.

It’s a London thing

Despite the gradual developments in other sectors, interest overall remains firmly focused on London. UK property firm Savills in its 2013 European Property Survey noted that the volume invested in UK grew by 12.5% over 2012 to EUR44 billion (US$57.3 billion), amounting to 38% of total commercial investment volume across the 13 countries surveyed, of which London accounted for 23% of total turnover. The firm expects London property markets to see growth topping 20% over the next five years, with central London seeing the highest growth at 25.6% between 2012-17, and highlights growing interest from the Middle East.

Heaton of LCP also commented of the recent London luxury property fund that: “The world’s super-rich are viewing prime London residential property the same way as they do gold and there is a limited supply of both. Even taking into account the effect of the credit crisis, prices in this tiny six-square mile area have risen by an average of 8.2% each year over the past 15 years. Rental yields run at approximately 4.5% a year.” The attraction is obvious.

New opportunities

However, new opportunities do exist as investors seek to spread their wings in this growing market. Philip Churchill, a founding partner of London-based real estate firm 90 North Real Estate Partners, confirms that: “We have seen considerable activity from our Middle East Shariah compliant investors over the last 12 months, with GBP125 million (US$190.9 million) of UK real estate acquisitions.”

He explains that: “Unlike the sovereign wealth funds who are willing to accept the low yields of central London, our institutional investors are looking for the higher yields available outside of London in established locations, with investment transactions concluded in a wide variety of sectors, including industrial, distribution and student accommodation.” And several investors are indeed moving further out of London in search of higher returns. Kuwaiti investment firm Dimah Capital this month acquired the Argos National Distribution Center in Stafford for GBP26.8 million (US$40.9 million) through a Shariah compliant transaction; following on from its previous purchase of the Bristol office of communications giant Everything Everywhere for GBP19 million (US$29 million).

Student accommodation has been one of the major target areas for investors not as concerned with the ‘trophy’ element, and interest is also growing in the infrastructure areas of healthcare and education. In 2011 Gatehouse completed the acquisition of a GBP30 million (US$45.9 million) new student residence in Glasgow, Scotland — its fourth acquisition of a student accommodation property. Last year it acquired a further two in Liverpool and Loughborough, developed by and leased to the Watkin Jones Group. According to Fahed Boodai, the chairman of the board at Gatehouse: “Student accommodation is a sector of great importance that we believe will deliver strong investment opportunities for the maximum benefit of our UK clients.” The sector is an established part of the UK real estate market worth around GBP6.5 billion (US$9.9 billion) and is one of the few to experience consistent rental growth over the past few years, making it attractive to new buyers.

The industrial sector is another key growth area to watch. The recent Ernst & Young report noted that according to data from international distribution firm ProLogis, every US$1 billion of sales generates warehouse demand for 72,000 square meters of warehouse space in the UK, Germany and France; and highlighted the area as a focus for future growth. BLME last year launched a GBP200 million (US$305.3 million) Light Industrial Building Fund (LIBF) targeting returns of 8% and focused on theindustrial and warehouse sector. Derek Weist, the director of asset management at BLME, said at the launch of the fund that: “Middle Eastern investors are increasingly looking to diversify their UK property investments outside of London residential and commercial property. We believe that this sector is set to experience a recovery value similar to central London.”

Spreading the focus

There is also a possibility that Islamic investors might finally shift their focus away from the UK and towards other European markets, as their economies begin to stabilize and opportunities become more attractive. Jones Lang LaSalle notes that in the fourth quarter of 2012 France, Germany and Scandinavia all saw increased activity, with more than US$13 billion transacted in Germany in the final three months of the year — an increase of 66% on 2011.

“Limited finance has meant that the market has remained dominated by investors seeking core, low risk assets and consequently the three major markets (UK, Germany and France) were the most active in Q4 2012, accounting for more than 60% of total volumes,” said the real estate firm in its April 2013 Outlook. However, even though the UK continues to be the most liquid market in Europe, transaction volumes showed a 21% decrease on 2011, totalling US$2.9 billion. In comparison, investment volumes in France totalled US$1.8 billion, while Germany posted a 32% increase, totalling US$1.5 billion. Ernst & Young notes that: “Developers are shifting their focus from commercial to residential properties, especially in gateway cities. They are tapping into strong demand from wealthy individuals in the Middle East and Southeast Asia who are investing in Europe, either buying second homes or diversifying into stable markets. We believe in residential assets in stable EU countries. This will only get better over the coming period. For residential investors, especially in the UK and Germany, 2013 will be a key year.” The outlook is bullish for the coming year, with the firm noting that: “Optimism has returned to Europe’s real estate industry. Sentiment among industry leaders about the prospects for their businesses is more positive than at any time since 2008, despite the uncertain macroeconomic outlook. Equity for investment in prime commercial real estate is expected to increase, but bank debt is predicted to contract further.”

Adventurous investors

Investors are looking for value beyond prime locations and sectors, but they are also willing to take on slightly more risk. However, overall transaction volumes are expected to rise, driven predominantly by cross border investments. According to a recent Ernst & Young survey, the majority of respondents in 12 of the 15 countries surveyed predicted higher levels of interest from international real estate investors in 2013.

The UK real estate market continues to provide hope and the outlook for 2013 is optimistic. But investors must be careful not to be tempted by the strong performances of the past into areas where returns are flattening out. Adventure will pay off , and audacity may be the best entrance to what remains a long-term and lucrative sector.

Article from Islamic Finance News