London Hedge Fund Alley Rents Fall as Firms Close

Date: Tuesday, November 18, 2008
Author: Simon Packard, Bloomberg.com

Office rents in Mayfair and St. James's, the London districts with Europe's biggest concentration of hedge funds, are falling for the first time since 2005 as the alternative investment industry has its worst year in two decades.

The annual cost of renting new or refurbished offices in those neighborhoods, the most expensive in the world, fell 6.5 percent to 107.50 pounds ($168) a square foot in the six months ended Sept. 30, data compiled by Jones Lang LaSalle Inc. show. Incentives such as rent-free periods lowered the net figure to 95.96 pounds, the commercial property broker estimates.

Demand for space is falling as at least 350 funds in the $1.7 trillion hedge fund industry have closed this year amid the global financial crisis, including Peloton Partners' ABS Fund and MKM Longboat Capital Advisors' Multi-Strategy Fund. Client redemptions and forced asset sales have given investors losses for five straight months through October, the longest streak since 1990. The slump may push rents down to as low as 90 pounds a foot, Jones Lang of Chicago estimates.

``We're beginning to see a rental adjustment that will take us back to more realistic levels,'' said Lauren Buck, investment director of Grosvenor Group Ltd.'s London office property unit. ``Financial services drove the market to where we are.''

Grosvenor, the company that runs the property assets held in trust for Britain's Duke of Westminster, is the biggest landowner in Mayfair. The district and St. James's are part of the West End, where the most restaurants, theaters and stores in London are located.

Tax Breaks

The U.K. attracted overseas hedge funds and other financial-services companies during the past decade by offering tax breaks and a relatively low level of regulation. Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether the price of assets will rise or fall.

Permal Group, the fund of hedge-funds unit of Legg Mason Inc., agreed in September 2007 to pay a record 140 pounds a square foot to lease the top floor of an office on St. James's Square. That figure is unlikely to be beaten anytime soon.

``The West End is no longer immune to financial sector swings,'' said Anthony Duggan, head of research at property broker Drivers Jonas. With just 366,000 square feet (34,000 square meters) of new space coming onto the market by the end of 2009 in Mayfair and St. James's without tenants, rents probably won't fall to the 65 pounds a square foot seen in the 1991 recession, he said.

Sharp Demand Decline

West End rents fell at the fastest annualized rate of the London office markets in the third quarter, declining 5.3 percent compared with a 0.2 percent drop in the previous quarter, according to figures compiled by researcher Investment Property Databank Ltd.

Hedge fund start-ups clustered in Mayfair and St. James's because the private banks based there would steer wealthy clients their way to seed funds. Added attractions are proximity to expensive London neighborhoods, where many managers live.

``Since June, there's been quite a sharp reduction in demand, an increase in the number of small units coming to market and vacancies,'' said George Roberts, head of Jones Lang's West End team.

The main financial center in the U.K. capital is the City of London district, while Canary Wharf in east London is home to banks including Morgan Stanley, Barclays Plc and Citigroup Inc.

Looming Recession

Hedge fund alley's woes and concerns about the impact of the imminent U.K. economic recession have made investors reassess the West End property market. Until now, the market had better resisted the U.K. property market slump because of supply shortages and the diversity of tenants.

In the first 10 months of the year tenants leased 2.5 million square feet of space in the West End, or 14 percent below the average since 2002, broker Savills Plc estimates. That helped lift the vacancy rate to 4.5 percent from 4.2 percent in September, or the highest in more than two years, it said.

Moving Out

Goldman Sachs analysts estimate West End rents will fall 4 percent this year and slide 16 percent next year. Shares of West End REITs Great Portland Estates Plc and Derwent Plc have fallen by more than the 30 percent decline of the FTSE 350 Real Estate Index during the past three months.

For Mayfair and St. James's, the likely consolidation of the industry means ``increasingly, funds will look outside the West End to find the space they want,'' said Roberts at Jones Lang.

Some money managers are already moving out because they no longer need to be on the investor route and because of their technology needs.

Brevan Howard Asset Management LLP, which manages $27 billion in assets, will join DE Shaw & Co. in a move to 55 Baker St., a new office building offering larger and cheaper floor space.

Quantitative funds, which depend on computers to execute trades devised from mathematical models, need back-up generators, dual power supplies, cooling systems and fail-safe telecom links.

New Demand?

``Data center infrastructure is having a higher weighting now in decisions than two or three years ago,'' said Andrew Jay, EMEA region head of CB Richard Ellis Inc.'s technology advisory group.

Landlords expect that in time demand will pick up from new asset managers or private equity firms, for whom rental costs will represent a fraction of fee income.

``We're seeing demand from very senior people who have been laid off from the big investment banks,'' said Nigel Kempner of Grafton Advisors LLP, the asset manager of the 600 million-pound West End of London Property Unit Trust. While ``the market won't be insulated, we aren't going to see Armageddon.''

To contact the reporter on this story: Simon Packard in London at packard@bloomberg.net.