The L&G case : London office purchase 1992 / 2006

1. The L&G case: London office purchase 1992 / 2006

2. Case study • London office sale by UK insurance company, 1992 • 1990 development • 1991 25 year lease with 5-yearly reviews to market rents, upward only • Let to partnership of lawyers • End 1992: lease rent £760,000 (£50psf); market rent £296,000 - £370,000 (£20-25psf) • January 1993 sale – at what price?

3. Why the UK won’t join the Euro - yet

4. 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!

5. Sterling/$, 1985-1993 – Black Wednesday

6. Rental values and growth 1988-1993 - collapsing Lease signed Sale date Source: IPD, PFR 2006 … and these are appraised values…

7. Appraisal 1: Summary Cash flow (fixed) £760,000 Term: 23 years Long gilt: 8.4% Risk premium: ?% Required return: ?% Value: £?m

8. Valuation: December 1992 Term: Rent passing £760,000 PV pa, 23 years @ 10.00% 8.88 Capital value £6,751,246 Reversion: ERV £370,125 PV pa, perp @ 10.00% 10 PV, 23 years@ 10.00% 0.11 Capital value £413,349 Valuation £7,164,595

9. 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?

10. Appraisal 2: Summary Long gilt: 8.4% Risk premium: 2.0% Required return: 10.4% Value: £7.8m

11. 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

12. Appraisal 3: the German view Long gilt: 6.9% Risk premium: 2.0% Required return: 8.9% Value: £8.9m

13. Sterling/DM, 1992-2001

14. 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?

15. 2006 • 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?

16. Property and gilt yields appear related… Source: IPD, Datastream 2006

17. 2006 • 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?

18. Appraisal 4: summary

19. Appraisal 4

20. Performance 2001-6

21. 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?

22. 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