Why this family office is sticking with London real estate – an interview with its CEO

Commercial real estate yields in big city markets like London and New York may have taken a hit in recent years. But one CEO of a family office reckons investors in these markets should keep the faith, and not get too excited by better yields in emerging markets.

Over the last few years’ commercial real estate yields have been low in London and New York.  Before 2007, investors might have expected central London commercial property to provide annual yields of between 5-6%, whereas now these are typically 3-4% or even lower.

Even if the economy tanks, real estate in a central business district like Mayfair is the most likely to keep tenants

That’s led some family offices to seek higher returns outside of traditional markets and even look for opportunities in emerging markets, given high yields in some of these markets. Until recently, commercial real estate in some emerging markets has been yielding at least twice that of London and New York. But Mohamed Nadar, CEO of a London-based family office, is sceptical about investing in some emerging markets.  

“Our preference is very core commercial assets like offices in prime locations such as Mayfair in London,” says Nadar.  “This is because core assets have a very high chance of being rented out. Even if the economy tanks, real estate in a central business district like Mayfair is the most likely to keep tenants.”

Nadar reviews property opportunities all over the world and his decades of experience has refined his view of acceptable levels of risk and returns. During his time as an investment manager, he has seen two currency collapses, the first in Indonesia in 1997 and then in Turkey in 2018.  These episodes all but wiped out investments in these countries, despite being popular with real estate buyers before their difficulties. These problems have led him to be much more cautious of real estate investing in emerging markets.

“On paper, returns in developing countries are higher but the risks are also higher, especially the currency risk.  In Turkey and Indonesia, the symptoms of currency collapse were very similar,” says Nadar. “Investors took out loans in dollars to invest locally. But, of course, their income was in local currency. Everyone gets lulled.  They can borrow in a low-interest currency and then invest in a high return environment. Your buying at 2% and yielding 8%. You look like a great investor, as long as you get out at the right time!”

Of course, its normal in emerging markets for investors to hedge their currency risk.  “But often this is overlooked”, says Nadar.

“If the lease is in dollars and an unexpected political event happens, hitting the local currency, suddenly your tenants have to pay multiples on their rent, which they can’t afford so there is a stream of defaults, not just in real estate but the wider economy. Tenants can no longer afford the rent and stop paying.”

He adds: “Under these circumstances, the governments are sometimes sympathetic to guys who can’t pay.  So they often change the rules and you can’t enforce the dollar contract.”

Indeed, in September 2018, the Turkish government made existing real estate contracts in dollars illegal.  Within 30 days all leases had to revert to Turkish lira instead.

The risks in emerging markets aren’t just linked to currency issues, but also often stem from the speed of the local legal system, Nadar says.

“Even assuming everything else is equal, the legal system in these countries often doesn’t work very fast.  For example, the bailiff process, which is the last line of defence for any investor, is relatively predictable in the UK.  Everything comes with specific timelines. But something that might take a month in the UK might take a year in some emerging markets.

“Developing countries have rules but when you need them you will find you may not be able to enforce them in a timely manner,” says Nadar.

He also says working with locals can be challenging in some emerging markets.  “In theory, things like local contractors are cheaper in developing countries,” says Nadar. “But standards vary enormously.  Some contractors can be careless and this lack of attention to detail creates problems. These problems, such as a leaky roof, can become intractable.”

So this takes you back to developed commercial real estate markets like London, even if you consider all the uncertainties around issues like Brexit, say Nadar.

“If you buy top quality in London the risk of having an empty building is not high.  So we prefer to take property risk and not location risk. You can upgrade and renovate a property but you can’t do much with location.   If it’s a secondary location and the market goes bad you get hurt. And London is still strong. It’s not a frenzied market like it was two years ago but its still strong.”

“In London, you can buy transparently, rent the space out, collect the rent, evict bad tenants, find new tenants and sell relatively quickly,” says Nadar.

“You can’t do that in many other markets.”  

Keith Johnston is CEO of the Family Office Council, a London-based Family Office Network