There is more capital looking for a home this year in the UK - and few vendors. Denise Turner analyses opportunities in the UK

UK life and pension fund investors were rarely direct competition for Irish purchasers in the UK in 2003.

If the official statistics are to be believed, UK funds were substantial net dis-investors last year as a result of intense competition from debt-driven buyers, weakened occupational markets and a tactical play on equities.

The recent volatility of institutional investment flows highlighted in the graph below can partly be explained by their drive to reduce exposure to the M25 and central London office markets in favour of the retail sector and also, the trend to reduce exposure to direct property holdings in favour of indirect investment, which possibly accounted for up to 25 per cent of institutional spend last year, which is not picked up by the official statistics.

Many fund advisors, both internal and external, are reaching the conclusion that institutions are unjustifiably underweight in property, given its risk/return profile, lower volatility and the expectation that REIT legislation will be introduced in 2005 leading to greater investment product opportunities.

Current average property weightings of between 6 per cent and 8 per cent are well below the peak of 19 per cent reached by some funds in the early 1980s. In order to increase weightings to even 8-10 per cent, substantial amounts of capital will be available for direct and indirect property investment.

It would appear that funds are also happy with lower return expectations from property given an increase in their requirements at a time when the UK stock market is poised to outperform the property market in the short term. Gearing through indirect property vehicles is one way of improving returns and in turn outperforming the market average - a key short and medium-term driver of many fund decisions.

Unfortunately, many funds trade directly with each other, which will further reduce the stock available to Irish investors. UK funds, including Ing Real Estate, Aberdeen Investment Managers, Prudential and Insight etcetera have up to £500 million each to spend in the next six months, while several, like Standard Life, have allocated an additional £1 billion for property acquisitions in 2004.

Add to this increased cross border investment from the US, Germany, Australia and the Middle East, and it is clear that the supply of stock is unlikely to meet demand.

In recent months, the supply of good quality commercial investment stock has been relatively tight. Funds have been delaying and in some cases pulling out of sales while they wait for the opportunity to replace assets and avoid the need for further cash deposits.

In addition, weaker tenant demand in the office sector and a limited supply of new retail developments due to planning constraints have further reduced the supply of opportunities.

Competition for assets has intensified, particularly for popular stock like high yielding smaller shopping centres, central London retail and retail warehouse parks.

For example, the Castleford centre in Leeds, which provided an attractive yield of 7 per cent, received over a dozen bids and sold for a sum well in excess of the asking price - something which up until recently was mainly a feature of the Irish property market.

Demand for UK opportunities from Irish purchasers continues to gather pace. The only constraint to exceeding the reputed £2 billion of assets acquired last year will be the possible lack of fundable opportunities. There are now well over a dozen well- known banks, stockbrokers, accountants and tax consultants arranging syndicates using various tax and legal structures to meet the demand from their clients to access commercial property in bite-size chunks.

Known requirements for 2004 from the main syndicate promoters amount to well over £1 billion and this excludes individual investors and developers backed by Irish and overseas banks who are also keen to increase their exposure to overseas property.

In order to secure opportunities, Irish investors need to and are becoming more inventive, lean and aggressive. Direct approaches to developers as new or refurbished properties are about to be let and approaches to property owners where they may be overweight in a certain sector or location due to mergers between funds will be even more necessary this year.

In addition, concentration on long-term income where yields are lowest may be a little shortsighted given the relative value of property with shorter income where the property fundamentals stack up. Irish investors have had to react more quickly and decisively when an asset that meets most of their requirements becomes available as in many cases, a marketing period of no more than a couple of weeks can apply.

For example, recent acquisitions for our clients include the Royal Opera House retail portfolio (circa £80 million) and 11-17 Castle Street, Norwich (£9 million) where proactive approaches were made directly to property owners when the properties were not on the market.

In the case of 5 St Philips Place in Birmingham (circa £38 million) an approach was made to the developer as the letting was being agreed and at Fitzroy House in Mayfair (circa £10 million) the building was vacant and the purchaser will refurbish and re-let in order to benefit from an improving West End occupational market.

Some Irish investors are now taking advantage of this lack of supply and are taking profits on assets they have acquired in the UK in the last few years.

Hamilton Osborne King, through its UK associate, Knight Frank, has now sold over £50 million worth of stock in the UK on behalf of clients who were happy to pay Irish CGT at 20 per cent and move on.

To date, debt-driven investors have had a relatively clear run at prime well-let office and retail investments where institutions were unable to compete at sub 6 per cent (office) and 5 per cent (retail) initial yields. Although the interest rate increases to date have been moderate, with five- year swap rates now hovering over 5 per cent (fixed interest rate before bank margin) it is unlikely that private investors will be in a position to drive yields down much further without either contributing more equity to a deal or accepting lower annual total returns.

Increasing interest rates may suggest that yields will follow the upward trend leading to a fall in property prices but the weight of capital overhanging the market is likely to more than compensate for this, resulting in increased values/prices.

In short, with more capital looking for a home in the UK and no forced and few willing vendors, 2004 should be interesting!

Hamilton Osborne King and Knight Frank have recently published The Irish Property Investor which is available by registering at www.hok.ie/investors

Denise Turner is a director with Hamilton Osborne King, responsible for UK property investment acquisitions