Andrew 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 l London office sale by UK insurance company, 1992 l 1990 development l year lease with 5-yearly reviews to market rents, upward only l Let to partnership of lawyers l End 1992: lease rent £760,000 (£50psf); market rent £296,000 - £370,000 (£20-25psf) l January 1993 sale – at what price?

Andrew 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, 2011 Sterling/$, – Black Wednesday

Andrew Baum and David Hartzell, Global Property Investment, 2011 Rental values and growth collapsing 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£760,000 PV pa, %8.88 Capital value£6,751,246 Reversion: ERV£370,125 PV pa, 10.00%10 PV, %0.11 Capital value £413,349 Valuation£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, 2011 Sterling/DM,

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, 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…

Andrew Baum and David Hartzell, Global Property Investment, 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 rent760,000Long gilt4.50% Annual ERV psf37.50 Total ERV555,188Base prem1.50% Inflation2.50%Froth prem2.50% Prop prem2.50% Growthrealnominal Growth %12.75%Reqd retqtrlyannual Growth 25.00%7.62%Base1.47%6.00% Growth 30.00%2.50%Froth1.71%7.00% Growth 40.00%2.50%Prop1.71%7.00% Growth 50.00%2.50% Growth long1.00%3.53%Net exit value5,980,559 Base value5,503,736 Depreciation pa1.50%Froth value705,291 Depreciation pq0.37% Exit yield6.00% Review costs2.50%Total value12,189,585

Andrew Baum and David Hartzell, Global Property Investment, 2011 Performance Year endCapitalCostsRentNet cash flow 2001-£12,500,000-£593,750-£13,093, £760, £760, £760, £760, £12,190,000-£213,325£760,000£12,736,675 IRR4.237% Running yield5.804% 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