Europe

The future of overseas investment

The importance of overseas investment into the UK’s commercial property sector cannot be overstated. Between 2005 and 2015 there was £183.5bn of overseas investment into UK real estate, with more than £20bn in 2015 alone (CBRE report – United Kingdom Real Estate Market Outlook 2016).

According to Colliers International’s 2016 research and forecast report, Property Snapshot, international investors currently account for over half of all UK real estate transactions so far this year. For larger transactions (£100m-plus) in central London, overseas purchasers accounted for 88% of transactions in 2014 and 81% in 2015 (Cushman & Wakefield). This investment is not only used to acquire or refinance existing assets, as some of the most recent landmark regeneration projects in the UK have all benefited.

Indeed, large-scale regeneration such as King’s Cross (AustralianSuper), White City (Mitsui Fudosan UK) and Battersea Power Station (a consortium of Malaysian investors) have been realised through overseas investment. The redevelopment of Royal Albert Dock to create a new business district in London is the next landmark asset that will be transformed as a result of Chinese investment (ABP and CITIC Construction).

However, it is not just London that is attractive. The Northern Powerhouse that has been promoted by government is also attracting significant overseas investment, particularly from the Chinese. A good example is Beijing Construction Engineering Group investing heavily in Manchester’s Airport City, where Chinese businesses will be encouraged to take office space.

Attracting investment

At a time of potential uncertainty for the funding of regeneration schemes it is important to consider the key components which help to attract investment into UK redevelopment projects:

Joint ventures with local partners

On large-scale development projects, foreign investors often look to invest through joint ventures with a UK developer. For an overseas investor, key issues to consider in negotiations are likely to include:

• the proportion of equity (if any) the developer will contribute;

• the initial and future equity funding commitments and the terms and agreed levels of leverage of third party debt that can be raised for the project;

• the basis on which the investor rate of return is calculated and the point at which the developer’s promote or carried interest becomes payable;

• resolution of disputes, lock-in periods, restrictions on transfers and change of control; and

• regular and detailed reporting obligations.

Typically however, the key components of a successful joint venture fall outside of the legal framework – a comprehensive business plan and trust between the partners. Much of the comfort and control for a passive overseas investor is derived from a clear business plan, which the developer should present. In addition, overseas investors should resist deviations from this plan during the life of a project without investor approval. That said, there is a balance to strike, and it is important that an overseas investor has faith and trust in its development partner to enable the developer to manage the development on a day-to-day basis without overly restrictive approval requirements, which may prove an administrative burden on the developer.

Streamlined planning system

An efficient and clear planning system is required to ensure that the UK retains its draw to overseas investors.

At a local level, planning authorities must continue to be tasked with ensuring that their local plans are up to date and have clear and flexible allocations to ensure that development is not prohibited by stifling planning policy.

At a national level, recent legislation such as the Housing and Planning Act 2016 includes measures such as “permission in principle” for housing-led development and the government should be lobbied to ensure that the necessary regulations supporting this legislation are not delayed by Brexit turbulence in parliament.

Stakeholder infrastructure investment strategy

The key to a number of successful regeneration schemes has been the confidence a diverse group of stakeholders can bring. The commitment shown by several organisations, such as the University of Arts, Imperial College, UCL, Sadler’s Wells and the Victoria and Albert Museum, all served to instil vitality to the projects and attract overseas investment.

Government commitment to a scheme can often be best demonstrated by transport and infrastructure investment. London and Continental Railways (LCR) (wholly owned by the Department for Transport), has played a critical role in the regeneration of King’s Cross and the International Quarter at Stratford. LCR is now trying to stimulate this kind of regeneration on a similar model at the Mayflower Quarter in Manchester.

The Northern Line extension and Crossrail will have a similar impact, along with TfL’s plans to redevelop some of its estate holdings in London.

Iconic landmarks

Overseas investment in the revamping of Battersea Power Station, King’s Cross and White City has been driven by the redevelopment of iconic landmarks, which in turn triggers a ripple effect of further investment for the regeneration of that area. Confidence in UK redevelopment projects may be affected in the short to medium term by Brexit. However, well designed schemes for the redevelopment of iconic landmarks, which pick up on the positive lessons of previous high-profile projects and are backed by government and cultural stakeholders, are likely to stand the greatest chance of attracting overseas investment.

Availability of development finance

Availability of development finance has remained limited (and in the short term is likely to become more expensive as a result of Brexit), particularly for large speculative schemes. The recent De Montford lending survey revealed that only 45% of lenders would lend between £20m and £40m on development projects, falling to 15% of lenders on ticket sizes in excess of £100m.

To maintain a pipeline and expertise required for development finance, it is essential to continue with regeneration projects around iconic landmarks, which have been the focus of development finance lenders. King’s Cross and White City have both been able to secure high levels of development funding. Furthermore, investment by overseas investors helps overseas banks access these projects, thereby expanding the pool of lenders.

Development tax regime

Recent legislative changes have affected the UK tax treatment of overseas investors in UK real estate, especially in relation to residential property. The most recent change on 5 July 2016 was a new regime to bring the profits of non-UK resident property developers and other property traders within the scope of UK tax.

By way of contrast, the rules that apply to overseas investors that intend to hold commercial property for medium to long-term investment purposes still benefit from a stable and comparatively benign tax environment.

Whatever the strategy being adopted, if UK stakeholders can help potential overseas investors to navigate their way through the rules, it should be possible to present a stable holding structure that offers an effective tax rate on profits realised from their investments that is attractive compared to other jurisdictions.

Brexit implications

The UK’s decision to leave the EU has seen initial falls in the share prices of housebuilders and REITs and certain open-ended retail funds have closed for redemptions. There has been concern that some of the major overseas banks will look to move some of their operations from London to other European cities, including Paris, Frankfurt, Dublin and Luxembourg. Clearly the arrangements that the government is able to secure as part of the Brexit negotiations will be critical – although initial indications are that Paris and Frankfurt do not have the infrastructure or the space available to accommodate a large influx of financial services workers.

However, there are signs that overseas investors remain positive. Overseas investors, particularly US funds and investors who hold money in currencies pegged to the US dollar, are looking to take advantage of the devaluation of sterling in the coming 12 to 18 months and have been extremely active in bidding on properties brought to market by the open-ended retail funds which have been forced into sales to meet redemption demands. Interest rates are now likely to stay low for the rest of the decade. The Bank of England has already freed up £150bn by cutting banks’ capital requirements and has indicated that it will use other tools at its disposal where necessary.

Continued investment in UK development requires confidence and stability in the UK to be reasserted quickly. Overseas investors will undoubtedly study the impact that Brexit has on the take-up of office and retail space and demand for residential units at regeneration schemes in London and across the UK. The government needs to make bold statements backed up by bold actions to demonstrate that it remains a country that welcomes workers and students from the EU and beyond. In parallel, developers need to exude confidence and to avoid contagion of negative sentiments. The success and vitality of development schemes in the UK depends on this.

Nick Saner is a senior associate in real estate, Robert Share is a senior associate in planning and James Burton is a tax partner at Allen & Overy LLP

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