Newly Permitted Development.

I hadn’t been aware of the change to the Use Classes Order that came into force this month.  The new permitted development right allows the change of use of a building and any land within its curtilage from light industrial (Use Class B1(c)) to residential (Use Class C3).  It will be for a temporary period of three years, starting from 1 October 2017 (although the PDR from office to resi was soon made permanent).  It’s also focussed on small sites.  The gross floorspace of the existing building cannot exceed 500 sqm.  Local authorities can potentially withdraw these rights, by using Article 4 directions. According to Firstplan, a number of local authorities in London seem to be already applying for exemption under Article 4.

It will be interesting to identify the type of units where conversion might be most viable and, therefore, most likely.  I’d suspect that the best type of units would be adjacent to or in residential areas, be of traditional brick construction, be high enough to put in a mezzanine.  Whilst, it could lead to a quite a lot of new substandard development, I suspect that the bigger effect will be that the permitted development right will give developers more leverage when trying to get permission to demolish and rebuild – although that could involve affordable housing delivery.   Fairly obviously, there’s also likely to be concentrations in area with the most light industrial stock.  In 2015, 31% of all office to resi conversions using PD rights in London were in LB Croydon.

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Superstars or pools of risk?

As ever, the recent UBS Global Real Estate Bubble Index makes for interesting reading – although why Reading isn’t there, I don’t know.  They point to the growing concentrations of wealthy individuals in a relatively small number of areas in a relatively small number of global cities.

The intuition is that the national and global growth of high-wealth households creates continued excess demand for the best locations. So, as long as supply cannot increase rapidly, prices in the so-called “Superstar cities” are supposed to decouple from rents, incomes and the respective countrywide price level. The superstar narrative has received additional impetus in the last couple of years from a surge in international demand, especially from China, which has crowded out local buyers. An average price growth of almost 20% in the last three years has confirmed the expectations of even the most optimistic investors.

Basically, the argument is that the 0.01% will pay huge premiums to be close to each other.  Sounds fairly plausible.  However, the main global financial centres can also be viewed as concentrated pools of risk.  As quantitative easing has fuelled rising asset prices, the global cities have large pools of interlinked and interdependent global real estate investors, lenders and intermediaries occupying, trading, owning, developing etc. They all look exposed to a global or national systematic shock.  Seeing an Indian company like Lodha secure over half a billion pounds for the re-development of 1 Grosvenor Square in London from M&G looks like a good example of this concentration.

Carry on local authority reduced?

Max Freed directs me towards an Estates Gazette article indicating that the strange life of local authority investment in commercial property fuelled by cheap loans from the Public Works Loan Board could be coming to an end.  It’s also in the Times

Treasury and Department for Communities and Local Government officials are reviewing investments in land and buildings by local authorities, accumulated using low-cost loans provided by the Public Works Loans Board. Local authority spending on land and buildings more than doubled last year to £2.8bn from £1.2bn in 2015-16

As I’ve said in a few previous blogposts, it’s been the House of Commons Public Accounts Committee that first picked this up and the Financial Times have been reporting on the story for over a year.  Let’ see what the budget actually does.

Retail contagion?

It seems that changing sentiment/expectation on the future of shopping centre values has arrived in the UK.  In May I referred to the performance of retail REITs in the US but pointed out that there was

…no sign of contagion to the UK yet, the share price of Intu remains roughly in the same place as it was three months ago.

Things seem to have changed markedly.   The two REITs with most relative allocation to retail – Intu (c280p to c230p) and Hammerson (c600p to c 530p) – have experienced substantial share price falls from the end of July.  In contrast, Segro’s and British Land’s share prices have stayed broadly flat.

Judith Evans has a good piece on this shift in the FT and on changes in the retail sector more generally.  She points to the sale of Bluewater at a discount to its previous valuation and very large discounts to NAV in the retail REITs

Intu is trading at a discount of 43 per cent to the book value of its assets, and Hammerson at a discount of 31 per cent, according to Numis figures, against an average 17 per cent discount for real estate investment trusts.

Albeit British Land have been trading at a c30% discount ti NAV, it’s quite a stunning figure for Intu.

It means that the market thinks that, taking into account Intu’s debt etc., the company is worth nearly half the value of its assets.  Either the stock market is wrong, the asset valuations are wrong or both are wrong.  Such a discount is either a strong buy signal (prior a private equity company taking it?) over or a signal suggesting that asset valuations are about to fall significantly.  Again, it could be both.  It will be interesting to see how or whether the IPF Consensus Forecasts for shopping centres shift next month.  During the summer, forecasts for shopping centre rents and values were basically flat for the next 3-5 years in nominal terms with real falls in rental and capital values expected.

London offices

Judith Evans in the FT provides an interesting overview of trends in the investment and leasing sectors in the prime central London markets.  With Chinese investors as the marginal buyers for prime stock, it seems that most other investors are holding back.  Quoting Jefferies’ Mike Prew and others.

“Global funds, British property groups and American and Canadian investors have all pulled back from UK — which really means London offices — commercial real estate investment.” One property lawyer, who asked not to be named, warns: “If you don’t deal with the Chinese, [in many cases] you’ve got no one to deal with. The market is very thin.”

It’s difficult to know how deep that particular pool of capital is.  With increasing local regulation and illustrating the glabalised nature of the central London market, one commentator states that the actions of the Chinese premier Xi Jinping are now more important that Teresa May for the future of prices in the prime central London market.

The growing importance of the trendy co-working space in the letting market is also apparent.  The resilience of rents

…has been driven in part by serviced office providers such as WeWork, the privately owned US company that has stormed into the market over the past three years, leasing 24 central London sites. Rivals such as Blackstone-backed The Office Group have also been expanding. Co-working providers accounted for almost a fifth of all new take-up of central London offices in the first half of 2017, according to the property agents Cushman & Wakefield.

Fingers crossed that the Wework business model is robust.

Redrow revealed

Here‘s a very good piece by Phil Oakley taking an analyst’s view of Redrow.  It’s highly informative and instructive.    He spends a lot of time on their land holdings.  My only quibble is that I don’t really see land under option as being highly valuable for house builders.  The house builders have to pay about 90% of the Market Value to the land owner once planning permission is obtained.  They’ll typically make some money from the exercising their option but the vast majority of the land value uplift will go to the land owner.

The end of viability assessment?

Well, the DCLG seems to have chucked quite a few (proposed) grenades into the planning system last Thursday in their consultation document Planning for the Right Homes in the Right Places.  The proposed changes to the use of viability assessments in the planning system seem to have really come out of the blue.  Some strong words (my underlining)

Stakeholders have told us that the use of viability assessments in planning permission negotiations has expanded to a degree that it causes complexity and uncertainty and results in fewer contributions for infrastructure and affordable housing than required by local policies…the range and complexity of variables in assessing this are such that the process is seen as being susceptible to gaming; and is often viewed with suspicion by authorities, communities and other observers. In particular, estimating future values and costs can be manipulated to reflect a range of outcomes. Furthermore, appraisals are often not published on the grounds of commercial confidentiality. This means that the process is neither easily understood nor transparent.

The key wording seems to be

We propose to make clear in the National Planning Policy Framework that where policy requirements have been tested for their viability, the issue should not usually need to be tested again at the planning application stage (me again).

Given the “not usually” get-out, then this seems to be proposing to rule out the (ab)use of (biased) viability assessments to justify non-compliance with policy.  However, it’s notable that they are seeking advice on how viability assessments can be improved and made more transparent – perhaps a hint that they will be with us for longer.

It’s interesting that they are also seeking guidance on how to “publicise” the developer contributions secured through s106 and CIL.  I’d certainly recommend that the estimated cash value of planning obligations such as affordable housing, provision of education or health facilities etc.  should be made explicit during a planning application.

For instance, let’s say that 25% of affordable housing is being provided on a greenfield site in the south east of England where density equates to 40 three bedroom units per hectare and the average house price is £300,000.  That’s 10 affordable homes worth approximately £3,000,000.  Assuming that the developer is able to recoup half of the £3,000,000 by selling them to a housing association, that’s still £1,500,000 per hectare secured through planning obligations from affordable housing.  It would be transparent to set out the cash value of any planning obligations at the application stage.