From boom to bust to Brexit: Tower rises in London amid uncertainty
It was a tricky time for the commercial real estate business in London. Within days, Britons would be voting on whether to remain in the European Union or leave. The French insurance giant Axa SA was trying to figure out how the outcome would affect its investments across the Channel. Paris-based executives of Axa Investment Managers' Real Assets unit held a series of conference calls with their London colleagues to plan for what to do in the event of a leave vote.
One executive on the line from London - Harry Badham, Axa's head of UK real estate development - had a lot at stake. He was about to sign a construction contract that would launch Twentytwo, a Stg£1bn ($1.3bn) project to build the tallest skyscraper in the City of London. Unlike his colleagues, however, Badham was relaxed about the outcome. He was going to be out of town the day after the June 23, 2016, vote, having booked a trip in the expectation that remain would win. "When I told them I was planning to go fishing that day," he says, "they thought I was joking."
So the morning after, as harried traders in the City of London hunched over screens displaying the damage wrought on the pound by the surprise vote to leave, Badham was 70 miles away on the peaceful chalk banks of the River Test.
Unsurprisingly, his phone lit up. The project's investors - a global consortium of sovereign and pension funds - wanted to know what the shocking result would mean for them. After all, this was supposed to be one of the largest office buildings in Europe, and it was going up in London's financial district: Brexit ground zero.
You can hardly blame the investors for being nervous. The plot of land at 22 Bishopsgate has a haunted past. The previous owner had struggled to round up tenants following the financial crisis and halted construction in 2012, leaving a seven-storey concrete shell that came to be known as "the stump" before it was torn down. Even so, after what Badham describes as a post-referendum "moment of reflection," the group behind Twentytwo - Axa, its project partner, Lipton Rogers Developments LLP, and the investors - decided to push ahead.
More than two years later, despite all the uncertainty swirling around Brexit, Twentytwo is a reality. Still rising, it towers over any other structure in the City of London and is expected to reach 62 floors by the end of 2019.
Sitting in the fifth-floor marketing suite, Badham displays all the sangfroid he did in June 2016. "You can't just turn the taps off," he says. But you also couldn't just ignore Brexit and rush headlong into the future, at least not right away. "You couldn't sit there at that stage and say with a straight face as an investment manager, 'Yeah, don't worry about it. It will be fine.'"
So he waited awhile, and now he's sitting in a building that many thought would never be built. Badham says about 15pc of the space has been leased, with the first tenants, including insurers Beazley Plc and Hiscox Ltd., expected to move in in 2020.
That's if all goes according to plan. Twentytwo, which looms over the Bank of England where Bishopsgate meets Threadneedle Street, is a one-building history of the peaks and troughs that have characterised the City for the past quarter century. The story of the land it sits on is littered with building plans that went awry as different owners were spooked by one economic wobble after another. Now comes Twentytwo, having traversed a boom, a bust, and a boom again, finally to be built on the cusp of Brexit - and another bout of uncertainty.
The vote to leave the EU in 2016 immediately cast a pall over the London real estate market. At the time, developers had plans to build the equivalent of 50 skyscrapers the size of the instantly-recognisable Gherkin tower over the next four years, according to Mike Prew, a London-based analyst at Jefferies Group LLC. Following the referendum, he forecast an 18pc fall in rents based on the risk that international businesses might move as many as 100,000 jobs out of the UK. DWS Group GmbH, then part of Deutsche Bank AG, warned of an average fall of 10 to 15pc in central London office values over 2016 and 2017.
So far, the Brexit fallout has proved to be nowhere near that bad. Apple, Facebook, and Google have all committed to major new London headquarters in the two years since the vote as tech companies challenge financial ones for top talent. WeWork Cos., backed by SoftBank Group Corp., has become the biggest tenant in the capital, hoovering up space in more than 40 locations. (In 2017, Bloomberg LP, which owns Bloomberg Markets, moved into a new European headquarters on a 3.2-acre site in the City.) Indeed, the enduring demand for workplaces, plus the devaluation of the pound, which has made London cheaper for foreigners, helped the City rack up a record year for property investment in 2017.
For all that, Brexit-related unpredictability still exerts a powerful pull on real estate. City of London office rents fell just over 2pc in the third quarter of 2017 and haven't moved since, according to BNP Paribas Real Estate. That may understate the slowdown. Landlords are offering more generous incentives to keep headline rents high, thereby disguising real declines. Inducements, including rent-free periods at the start of central London office leases, increased to the equivalent of two years on a 10-year lease in 2018, up from 1.5 years in 2017, estimates broker GVA. Green Street Advisors Inc. forecasts a 5 to 7pc drop in City office rents by the end of 2019.
In that context, all eyes are on Twentytwo as the biggest bellwether of London's commercial property market. "I would be worried," says Nick Montgomery, head of real estate investment at Schroders Plc. Even with rents falling, he says, "I think we will see City vacancy rates getting up into double digits." As of the end of November, share prices of the two largest publicly-traded developers of London office space, Land Securities Group Plc and British Land Co., have fallen about 30pc and 20pc, respectively, since the referendum. By comparison, the FTSE 250 Index was down 7.7pc during that period.
London has long been the world's most international property market, but the share of money from abroad flowing into Twentytwo and other projects at a time of such political and economic uncertainty is striking. Overseas investment in properties in the City of London hit a record in the first half of 2018, accounting for 80pc of the total, according to data compiled by Savills Plc, a real estate broker.
Foreign spending on London offices during the same period was well over three times that invested in Manhattan properties, according to Knight Frank LLP. Another broker. Martin Greenslade, chief financial officer of Land Securities, says the risk-taking by overseas developers reflects investment timelines and return requirements that are different from those of domestic players. That's "if they require a return at all," he says.
Even so, says Toby Courtauld, chief executive officer of London-based developer Great Portland Estates Plc, "Given all the uncertainties, it's fascinating that there is so much capital out there looking to buy some of this riskier kit."
One of the most aggressive overseas investors in London since the Brexit vote is Hong Kong-based CC Land Holdings Ltd., which last year bought the cheese-grater-shaped Leadenhall Building next to 22 Bishopsgate for Stg£1.2bn. And the company has been in talks to buy land nearby for another skyscraper.
"Brexit is a real irritant," says Adam Goldin, head of the company's newly established UK office. But, he says, "we have a generational time scale so we are not looking at equity multiples on a five-year time scale. We are looking to acquire very high-quality real estate that can stand the test of time. We believe in the solid foundations of the UK market, and I don't think those fundamentals change, whether it is inside or outside of the EU."
In 2015, when 22 Bishopsgate was still a concrete stump, Axa and its partners - Canada's Public Service Pension Plan, British Columbia Investment Management, and Singapore's Temasek Holdings - paid about Stg£310m for the land. Axa Real Assets CEO Isabelle Scemama wasn't in charge then, but asked if she would have signed off on the purchase if she'd known Brexit was coming, she laughs, pauses, and says, "As an investor, you don't like uncertainty. And Brexit has generated some uncertainty."
Badham recalls the three reasons the partners decided to push ahead despite Brexit. First was the enduring appeal of the world's greatest cosmopolitan centre - "the schools and the culture and the amenities and the housing. London is London." Second, by analysing the development pipeline for London, plot by plot, project by project, he and his team concluded that vacancy rates were unlikely to rise too high. Finally, he reasoned that many of the planned commercial projects weren't going to get off the ground.
Badham's view has largely been borne out. If you scan the London skyline, you'll see a thicket of cranes, but most of them belong to residential projects. Over the past two years, there have been fewer office buildings started each year.
What's more, because of the financial crisis, development in London's finance-dominated Square Mile was constrained during the relatively economically healthy years in the run up to the referendum, so pent-up demand has come into play since then. The vacancy rate remains comparatively modest even as the UK approaches its 10th straight year of modest economic expansion.
"I am positively surprised by the level of demand that is there," Scemama says. "It confirms my belief that demand is there for good buildings."
But it's a renters' market. To lure them, Twentytwo is piling on amenities, from facial-recognition technology and an indoor climbing wall with dramatic 42nd-floor views to space for 1,700 bicycles and air and lighting systems that meet standards set by the International WELL Building Institute. More mundanely, the owners, with a nod to competition from the likes of WeWork, are offering tenants flexible office space set-ups and longer leases. Hiscox, for instance, signed up to take the 8th, 9th, and 10th floors on conventional leases that expire in 2037, but it will also have the option of using 90 desks on another floor in a short-term deal.
With its rich - and somewhat tortured - history, Twentytwo is a metaphor for the City of London's changing fortunes in Brexit Britain. There was a time when the Square Mile was fighting to maintain its status as Europe's premier home of big banking as Canary Wharf was offering a lot of open acreage for modern towers. Then along came the financial crisis, shrinking the workforce at many City companies. These days the City is competing with areas such as Shoreditch and Kings Cross for tech workers - the kind of people, to put it simplistically, attracted to bike parks and climbing walls.
Badham remains unworried about Twentytwo as it rises toward the heavens in this changing environment. "We get this British thing about 'Oh gosh, it is awfully big and it is awfully scary,'" he says. "In the context of the world and London's position in it, it really isn't." Anyway, he says, "when you've placed the building contract, it doesn't really matter what the rest of the world thinks, because you're building it anyway."