CoStar - The Knowledge Market: Toby Courtauld, Great Portland Estates.

So I noticed with this drink on the table your attention spans might well be a little shorter than they otherwise would be, so I'm going to rattle through this stuff at a real pace and hopefully some of it will resonate with you. It's a bit rich for me to stand here and start talking to you guys about the market, but Paul asked me to, and since Paul writes stories about us, I have to do what he asks me to do. So without further ado, let's fire through some views from GPE about market conditions and in particular how we are reacting to those conditions and what we think next year looks like. There we go. That's an agenda. But before I do that, most of you know who we are, most of you do stuff with us which is terrific, but for those of you who don't, a why not, and B this is to help you understand a little bit about us. We're a central London REIT. We only do central London. We're never going to do anything else. We've been listed since the 1950s. We're a mid-cap size, about just under 3 billion, and our model is very simple to understand, it's a bit trickier to execute well: repositioning properties. So that's buying stuff that needs some love and attention, got a bit ragged, redeveloping, refurbishing. We like the West End a bit more than the City, and I'll talk about why a little later. You've got to start from a low number: 45 quid is our average rent, which is a bit surprising when you remember that the vast majority of what we own is around Oxford Circus. Interested in total return, that's by necessity really. There isn't much yield in the West End, so we have to make money through the capital return, and we tend to take a lot of operational risk when markets support that. And because we do that, we very rarely take much financial risk, and gearing today is pretty low. In fact, when Lehman went, it was we think the lowest of any property company in the listed European space, and that was important because it allowed us with shareholders' help in 2009 and 2012 to go back into the market and start buying. And I'll talk about that in a little bit. And the consequence of that positioning was that TSR, total shareholder return, has been pretty good relative to the market. And if you look at this over here, you can see that over one year it's been in line but quite big numbers, 30%. Five years, 70% ahead, and over ten it's 240 odd percent ahead of our peer group. So that positioning point has been really important, and it's the flexing of the risk that makes a difference.

And the reason we flex risk is something you all know really well, and it is this: the market is seriously cyclical, and anybody who thinks that this is a game where we can just sit back and rely on lower for longer or the next ten years of super cycle or some of this stuff just needs to take a quick look at this slide. And how is it that lines like that trend off into a nice steady research analyst's view into the middle distance? It just ain't going to happen. And the question is not when we have a downturn, it is when are we going to have a downturn and what will it look like? Will it be another train crash like that one, or will it be a milder bump in the road like that one that we had after the dot-com bubble in London burst? And that's a moot point that we won't conclude on anytime soon, I don't think. But before we get to whichever of those two it is, there is definitely still quite a lot more growth to come, particularly in rents. And I think this is an important point I'll come to in a second. But before I do, because of that cyclicality, people like us — and we aren't alone in this game, Derwent plays this game as well, Shaftesbury to an extent, British Land and Land Securities a bit more in recent times — we flex our risk aggressively. And here you can see what I mean by that: the green is buying, the blue is capex developments and refurbishments, and the orange is sales. And you can see that after Lehman and the years thereafter we began buying really aggressively. We've been selling all the way through, making sure that we're getting some cash back in as we go. And here you can see the development exposure: we've been ramping it up over the last few years. We've actually been developing since 2010, and we've been making good numbers through here, and that's mainly Rathbone Square. Matthew mentioned it earlier. We just let the offices to Facebook, and all that blew up the committee the forecast blue. And that is about half a billion pound. It's the biggest development program we've ever had. So if we were really wild about rents or the market about to turn down, we sure as hell would not be positioned like that. But what you're not going to see us doing a lot of is green. London is not showing us much value in the green at the moment, and therefore you're likely to see us doing a bit more orange, sales. So I think for the next couple of years at least, you'll see us doing a lot of developing as rental markets support that, and you'll see us doing more selling than buying of assets because of where prices are. And in fact, if you compare our development exposure today to our peers, we are developing more than anybody else relative to the amount of assets we own at the moment, and we're doing so with one of the lowest gearing ratios compared to others. And you can see us down here, gearing in the 20s, low 20s. Most of the UK players are actually down here these days. Some of the Americans and Europeans are right at the far end. I mean, if you've got gearing up at 80% in today's market, you're taking a really risky ride, and when that goes down you're out of business, you're finished. Even some of the very large guys, SL Green, a very good business in New York, with gearing up at the 50% range, that's pretty high. It'll be interesting to see what they do in the next couple of years.

It's been really interesting. Conventional wisdom tells you that high gearing tends to deliver higher returns. In fact, if you look over the last five years, that line going that way tells you that the highest shareholder returns have been at the right-hand end, typically coinciding with lower leverage, and that has been unusual. I don't know why that is. I think it's... is it that investors have been running from risk? Is it that returns have been so high that you haven't needed gearing to make them higher? I don't know what it is quite, but certainly it is the case that those with the lowest gearing have actually been performing better than those with higher gearing. Now let's just talk about market conditions and what happens next for a minute. We spend a lot of time thinking about the issues that will determine how markets move in London, and what we have identified is that when we're thinking about yields, there's only really one thing that matters, and it's the weight of money. That's the correlation between the weight of money coming into the market and what happens to yields. And when we think about rents, it's GDP, employment growth, and vacancy rates. There are all pretty strong correlations in each case. You've got a green arrow telling you that things have recently at least been moving in the direction to support improvements. Now, as we'll see in a minute, I'm a little bit worried about that one, and I'm a little bit worried about yields generally, but rents I think it's fair to say we've got a good story ahead of us for at least the next 18 to 24 months. And the reason for that is this: economic growth. CFOs, who tend to be the guys who sign off the leases or sign off the search for a new office, have been taking significantly more risk. They've had an appetite for risk they didn't have a few years ago, and you can see that in this survey. Strong pick up from 2011 business activity in London, strong pick up from where we were trending in that period after Lehman. That's the... if you remember, 2011 summer was pretty miserable. The Greeks looked like they were about to blow up, the Portuguese almost did, the euro was in an existential problem for a while. That changed in the spring of 2013, and we really saw businesses began to pick up their interest levels in expansion. And you can see it over here again. And London's GDP forecast for the next three years is somewhere in the threes. I think it might come down a bit from there. I think that what's going on in China at the moment will possibly just temper that enthusiasm a little bit, but it is still forecast to grow ahead of the UK overall. So you've got growth, and growth means headcount rising. Businesses in London are typically taking people on today, and they are not shrinking. And you can see that in this survey: next five years, London businesses reckon that they will increase headcount. 73% of them reckon they'll increase headcount, 58% by more than 10%. And if you have been battening down the hatches from 2008 through say 2011, 2012, 2013, you've run out of space. You're now hiring people, your building's a bit knackered, you've got to move. 36% of them are saying they're going to move. I expect that to increase further.

So you've got GDP growth, you've got headcount growth, and crucially you've got supply that simply is not the issue that a lot of people will tell you that it is. This is the long run of spec supply. You can see 1990: 14 million square feet of speculative development. The next peak, 2003, dot-com bubble burst: 10 million. The next peak: 6 million. Last year: 5 and a half to 6 million. You can see that it is forecast to drop again in 2015. But this dotted area is the amount of that space that is getting committed to before the building is finished, and the pre-leasing story is telling you a lot about what's going on. And we expect quite a lot of this green and yellow to be consumed by tenants before it ever finishes. Witness Facebook and our scheme in Rathbone. The second point about this slide is of these bars, the yellow is the West End, which is where we, as I said earlier, prefer to be. There's simply not enough. You add all that up and it's about 3 million feet. This is W1 and a bit of W2, I think. But you can see that 3 million feet in a market of about 100 million feet isn't going to cut the mustard. We have a market share of around about 4%, and yet we are doing 25% of all of that yellow. So we have taken a big bet on that yellow. We just don't think there is enough. Planning is not making it any easier. Westminster have been shedding people, their budget is halved. They do not have the capacity to deal with the requirements that this city is imposing upon it, and I don't see that changing anytime soon.

So market view overall then: for rents, these drivers in the main are green. For yields, the weight of money, the most important driver, remains green for us. Therefore we're forecasting rental growth in our business of something around about 10%. I think that's now beginning to look a little bit conservative. Let's see. We've got results out in a month or two, six weeks, and for the half year we'll be able to see how we're doing against that number. For yields, we're saying they are trending flat at the moment, but I think we're going to see medium-term a bit of expansion. And the hope we have is that the rise in rents is enough to offset the expansion in yields. Why do we think there's going to be an expansion in yields? Nothing more than how much lower can they go, if at all. It seems to us impossible to have yields in the core of the West End for office buildings lower than the low 3s. We're into record territory in this market as well. The QE experiment is undoubtedly going to unwind at some point, and whether or not interest rates go up, our sense is that buyers are becoming much more choosy, and they've got more to choose from. The amount of stock in the market today is roughly double what it was 12 months ago to sell. So just a last comment on the market, because I think this one is worth pausing on for a moment. This is tracking rents over the long term in green in the West End and yields in blue. And what we found is that yields, as we might imagine, lead rents. So the prime yield typically dips or starts to rise ahead of rents moving in the opposite direction. If you go back to the exit from the European Exchange Rate Mechanism back in the early 90s, the yield story turned positive there, and five quarters later it's come off its bottom, but five quarters later rents began to rise. Now if you track all the way through, you'll see that same basic sequence happening every time you get an inflection point in the market. And today, well, we've got rents that have been rising quite strongly, we've got yields that have been falling pretty strongly. They're probably now trending flat, and the message from this slide is when those yields turn, you have got between two and I think the longest here is seven quarters. History would tell us before rents will go negative. Now let's hope it's seven, not two, and I think it is going to be nearer seven than two. And I think, as I say, that yields are going to trend flat for a little bit, but we are not at the beginning of this cycle, and that's quite an important message when thinking about positioning of a business as we have to do all the time.

So given that, what actually are we doing? And I'm just going to run through before I wrap up a couple of things that some of you will be familiar with that we're up to. East End of Oxford Street: we love it. We would love to have done more down there. We have bought quite a lot in the buildings that are highlighted here. We did buy that's Rathbone, that's Oxford House that we bought from Land Securities, and that's a building we put together over the last 10 years from a variety of interests. All three of these are development sites, and that's Crossrail, and that's Crossrail. And this end of the street is, you most of you will know, has been a bit of a dump for about three generations, in fact frankly since the Second World War. And for the first time since the war, it is turning into an interesting place to be, partly because of Crossrail and partly because people like us and Land Securities have been improving the building stock. And that's what we've been improving. That was what was on Rathbone when we bought it. It was an ugly shed built by the government, by the Royal Mail, without planning commission in the 1950s, virtually visible from the moon. The posties all drove their trucks here in the middle of the night and then went to the boozer here on the corner called the Postie, got plastered before they went back the next day to do it all over again. And it was a complete waste of space. This building was underutilized, it was massive. There is still an underground railway that takes mail across London under this site that we have to keep effectively open, but it's plain that it was a useless waste of space. And what we have done is demolished it. That was it coming down, and this was taken in fact in the autumn last year, with the core coming up for an office and residential building which will look like this. We're putting a new square in the middle. It's about 411,000 square feet in total. And this gives you a bit of a fly through from Rathbone Place heading west into the open space we're creating in the middle. On the right-hand side is, and to that end, there is a residential block with all of the usual amenities you'd expect in central London: pools, gyms, etc., 142 units, and there are 12 left. And then on the right here, we've now swapped sides, is the office building which is 217,000 feet, and that's the building that we've let to Facebook on a 15-year deal at a good rent without break. And if you look at the risk we have left here, essentially we have either pre-sold or pre-let 87% of this building, and we're not finishing it until February to March 2017. So you can see that this has been a great exercise in risk management, and it tells you a lot about the state of the market today that we've been able to do that.

The next big site for us is actually, I think in many ways more complicated and in many ways more interesting. Here we are in the traditional heartland of the surveying community, no longer, but it used to be. That used to be Knight Frank's building, and this is obviously of course the west side of Hanover Square. We pieced that site together over about six different acquisitions in between the period from 2006 through late 2007, I think it might have been actually. And what we had was a collection of dysfunctional knackered buildings from the 50s and one Georgian building. And what we are going to do with it is take it down and build a brand new office building, access from Hanover Square, new public space in the middle, new offices above, Bond Street retail, and a bit of residential in the corner. And underneath us is the new Bond Street Crossrail station. So in terms of location, this is about as good as it gets. The challenge we have is getting Crossrail to finish what they're doing so that we can then put up the space there. Any of you who were at Knight Frank will recognize the back of that building because that's where your offices used to be. And that's the Georgian piece. There was a Victorian ballroom that was attached to the back of it, which we in fact have planning permission to demolish. And the amusing thing about that was when we put in for planning, the Georgian Society said you can't do that, it's outrageous, it's the most wonderful piece of Georgian architecture. In fact it was Victorian, and their arguments didn't cut much mustard. This is an aerial from about 18 months ago, and what you see here is the site in its entirety, and those holes there are the service entrances into the Crossrail station which is being built underneath it. And there is on the internet in fact a fantastic drone piece of film that Crossrail took, it might have been part of the video actually they showed on TV a couple of months ago, of a drone flying down into these holes and through the tunnel network during construction. And they are massive. This is the eastern end of the station, the western side of which comes out in Davies Street which is about 250 metres away, and the platform is going to be that long. So these are huge endeavors, and hopefully we'll get the space back from them sometime during next year, which will allow us to begin construction of the site thereafter. But we will wait and see. Either way, it's going to be a hell of a development when we can get going. That's what it looked like from the square itself: office entrance over here, station entrance over here.

So just by way of a wrap-up: change, quite a lot of change in our industry, not as much as in many other industries mind you. I think fundamentally we all are always going to need space and will want to interact face-to-face, but we have got a lot going on. And I love this chart, I think it tells a huge amount. This is over the last 40 odd years what's happened to the cost of space relative to salaries essentially. And if you were a finance director in the 1970s, you would have seen that your office rent in London was roughly half your salary bill. And by the time you got to the crisis we've just lived through, that had gone from 30 to 5. And that tells you two things: one, rents have been growing slower than most measures, and that's the City obviously in blue, and in particular they've been growing slower than salaries. So if you are a finance director today, you are going to be far less concerned about the cost of your space than you would have been a generation ago. It doesn't mean you're not going to focus on pounds per foot or cost at all. What I'm saying however is you've got many other equations to think about, and that change I think is a huge positive for cities like London where they are perceived to be quite expensive. The other thing going on in the decision these people are making is where they want to be. We have seen without question a sense that London has gone from being the City and the West End to being London. Most of you guys are beginning to think about the way you manage your clients from a London standpoint rather than a division of West End and City. And that footloose nature is very important because your clients are just as likely to pick a centre that they've never looked at before today as they are one that they've traditionally been in. We've moved lawyers from Mayfair down to the South Bank where they have been for the last 200 years. So there's an awful lot going on from that perspective too. Technology is changing what we do with buildings, but it isn't taking the building out. Businesses' needs are... are we ripe for disruption? People fundamentally still need space, and I think that's a very important factor when we begin to worry about how businesses are going to use space. The fact is they are still needing space, and in the main they want to be in dominant urban centres. They don't want to be scattered around the world on business parks, very rarely do they want that. And increasingly we think that they will want at least some representation in key cities. But it doesn't mean that we can be complacent by any measure. And I think there are some big things for us to watch. And clearly the one at the moment is Corbynomics. I know about you lot, but I'm having real difficulty understanding quite where he fits into the lexicon of sense. I mean economically, some of the things that we are likely to see were he ever to become Prime Minister will be very very difficult for us to understand and manage around. Whether it is people's QE, whether it is renationalization, whatever it may be, that the burden of regulation and tax will become a real problem, not personally but for businesses and therefore sentiment. I think so, we are cautious about that. However, it's not as though the other lot are any better frankly, because the EU referendum I think poses a significant risk to us over the next 18-24 months. And from my standpoint, and this is a personal view, I hope that sense prevails and we find a way to persuade people generally that it's in our interest, certainly London's interest, to remain within the EU. The economic story as well, Matthew touched on this: there is a lot going on. The Chinese issue is real. I'm not seeing yet businesses saying we're putting on hold expansion plans, but we are going to see unquestionably earnings downgrades in UK plc as a result of what's going on in Asia. And I think that could in time just put a little bit of a dampener on some of our growth plans. But equally, I am nothing other than positive at the moment, and I'm fundamentally positive because the supply-demand dynamic in London is so much in our favour that even with some of these wobbles, our sense is they will be short-lived. And by the time we trade through them into next year, we think we will still see rents moving in the right direction. 2017, 2018, try guessing when we're going to see that rental market turn down. That's beyond us. I don't think we need to do that yet. We're not having to make decisions that far out. But for now, for at least an exercise of 12 to 18 months, our view remains pretty positive. And on that note...