Office Markets & International Financial Services

Transcription

1 Towers of Capital Office Markets & International Financial Services Colin Lizieri Professor of Real Estate Finance School of Real Estate & Planning Henley Business School The University of Reading

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3 Towers of Capital Office Markets & International Financial Services Colin Lizieri Professor of Real Estate Finance School of Real Estate & Planning Henley Business School The University of Reading

4 This edition first published Colin Lizieri Blackwell Publishing was acquired by John Wiley & Sons in February Blackwell s publishing programme has been merged with Wiley s global Scientific, Technical, and Medical business to form Wiley-Blackwell. Registered office John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom Editorial offices 9600 Garsington Road, Oxford, OX4 2DQ, United Kingdom 2121 State Avenue, Ames, Iowa , USA For details of our global editorial offices, for customer services and for information about how to apply for permission to reuse the copyright material in this book please see our website at The right of the author to be identified as the author of this work has been asserted in accordance with the Copyright, Designs and Patents Act All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by the UK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. Designations used by companies to distinguish their products are often claimed as trademarks. All brand names and product names used in this book are trade names, service marks, trademarks or registered trademarks of their respective owners. The publisher is not associated with any product or vendor mentioned in this book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold on the understanding that the publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required, the services of a competent professional should be sought. Library of Congress Cataloging-in-Publication Data Lizieri, Colin. Towers of capital : office markets & international financial services / Colin Lizieri. 1st ed. p. cm. (Real estate issues) Includes bibliographical references and index. ISBN (alk. paper) 1. Offices. 2. Office buildings. 3. Commercial real estate. 4. Financial institutions, International. 5. International finance. I. Title. HD L dc A catalogue record for this book is available from the British Library. Set in 10/13pt TrumpMediaeval by Newgen Imaging Systems (P) Ltd, Chennai Printed in Singapore

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7 Books in the series Greenfields, Brownfields & Housing Development Adams & Watkins Planning, Public Policy & Property Markets Edited by Adams, Watkins & White Housing & Welfare in Southern Europe Allen, Barlow, Léal, Maloutas & Padovani Markets and Institutions in Real Estate & Construction Ball Neighbourhood Renewal and Housing Markets Edited by Beider Mortgage Markets Worldwide Ben-Shahar, Leung & Ong The Cost of Land Use Decisions Buitelaar Urban Regeneration in Europe Couch, Fraser & Percy Urban Sprawl Couch, Leontidou & Petschel-Held Real Estate & the New Economy Dixon, McAllister, Marston & Snow Economics & Land Use Planning Evans Economics, Real Estate & the Supply of Land Evans Development & Developers Guy & Henneberry The Right to Buy Jones & Murie Economics of the Mortgage Market Leece Housing Economics & Public Policy O Sullivan & Gibb International Real Estate Seabrooke, Kent & How British Housebuilders Wellings Mass Appraisal Methods Kauko & d Amato Forthcoming Building Cycles & Urban Development Barras Transforming the Private Landlord Crook & Kemp Housing Markets & Planning Policy Jones & Watkins Management of Privatised Housing Gruis, Tsenkova & Nieboer Affordable Housing & the Property Market Monk & Whitehead Property Investment & Finance Newell & Sieracki Housing Stock Transfer Taylor Real Estate Finance in the New Economic World Tiwari & White

8 Acknowledgements The ideas presented in Towers of Capital have evolved over a long period and have been shaped by so many conversations, debates and arguments over the years that to single out any individuals who have, wittingly or unwittingly, contributed would almost be unfair. I am very grateful to my colleagues in the School of Real Estate & Planning at Reading, for their ideas, suggestions, and for their patience and for covering my work while I was on sabbatical completing the text. Particular thanks are due to those who read and commented on drafts of chapters: Phil Allmendinger, Michael Ball, Peter Byrne, Steve Devaney, Franz Fürst, Charles Ward, with apologies to anyone else I have omitted. The book has been shaped, improved and made possible by my many friends and colleagues in the international real estate research community. A number of individuals and firms have provided data: many thanks to all of them both for the data and for tolerating the queries and questions about it which inevitably followed. I should properly acknowledge three individuals who have made major contributions to the development of my ideas. First, to Geoff Dobilas from GHK International in Toronto: Geoff helped with my early attempts to sketch out the links between international finance and office markets nearly two decades ago and has been there ever since to insult me, distract me and prick pretensions. I owe a great debt, too, to Charles Ward (University of Reading) and to Steve Satchell (University of Cambridge). Both of them over the years, as friends and as co-authors, have forced me to tighten up my ideas and to wrestle with theories and techniques from economics and finance. My family and friends have borne the brunt of the writing of Towers of Capital: particular thanks to my son Neil and to Ruth Jordan for keeping me on track, I am truly grateful. Most of all, though, I must acknowledge my mother, Marjorie Lizieri, who taught me to ask why and how, not what, to search for explanations and to try to understand how the world is shaped. This book is dedicated to her memory. Colin Lizieri, Reading August 2008

9 Contents About the Author Introduction x xi PART I SYSTEMS OF CITIES AND CITIES OF FINANCE 1 Introduction 2 1 The Urban Hierarchy and Global Cities Introduction Cities and the urban hierarchy World cities, global cities Cities, space and finance 31 2 International Financial Centres and Global Cities Introduction Concentration in financial centres Information technology and cities Agglomeration and concentration IFCs, concentration and office markets 60 3 A Sense of History: Development and Inertia in the International Financial Hierarchy Introduction A sense of history The age of catastrophe Asian and Middle Eastern markets Lessons of history: a tentative conclusion 81 PART II INSIDE THE OFFICE MARKET 87 Introduction 88 4 Occupational Demand, Office Space and Rents Introduction Land value, land rent and financial services Rent models and rental adjustment Empirical evidence of rental adjustment processes in major office markets 105

10 viii Contents 4.5 Changing business practices and the demand for office space Employment, volatility and the use of space The Supply of Space Developers, development cycles and research Development, building costs and property value Economic models and developer behaviour Real options and developer strategies 144 Investment, Capital Flows and the Office Market Introduction Real estate in the portfolio Investment patterns and investor behaviour Real estate vehicles and the portfolio International real estate investment Real estate capital flows Investment, capital flows and IFC office markets 180 PART III INTERNATIONAL FINANCE, GLOBAL OFFICE MARKETS AND SYSTEMIC RISK 183 Introduction Booms, Bubbles, Crises and Contagion Introduction Financial markets, co-movement and crises Booms and bubbles Real estate in booms and bubbles Bubbles, crashes and IFC office markets 214 Globalisation, Ownership and Innovation in Real Estate Markets Introduction: innovation in real estate investment and ownership Innovation in property investment vehicles Global real estate investment Ownership patterns Conclusions: innovation, ownership and real estate risk in IFCs 255 All Fall Down: Global Financial Centres, Real Estate and Risk Introduction Retracing the threads 259

11 Contents ix 9.3 Market integration, globalisation and systemic risk Some preliminary evidence Global financial centres and office market risk: some policy implications 287 Epilogue 297 Bibliography 303 Index 321

12 About the Author Colin is Professor of Real Estate Finance in the School of Real Estate & Planning at the University of Reading s Henley Business School. He is Director of Research for Real Estate & Planning and served as Head of Department. Colin has worked in real estate for nearly 30 years. His principal research covers modelling of real estate investment, office markets and international real estate. He has carried out research and consultancy for the European Union, the Norwegian Government, Her Majesty s Treasury, the Department of Communities and Local Government, the Home Office and a wide range of public and private sector clients including PREA, the RICS and IPF. He led the Investment Property Forum research projects on commercial property market liquidity and on the pricing of property derivatives. He has published widely in academic and professional journals, with over 100 publications and is the co-author of The Economics of Commercial Property Markets and has been asked to present research and lecture in over 30 countries. In 2004, he was awarded the International Real Estate Society achievement award for outstanding achievement in real estate research, education and practice at the international level and in 2005 was elected an honorary fellow of the Society of Property Researchers in recognition of an outstanding contribution in the field of property research.

13 Introduction For all the many cultural and physical differences that distinguish the developed world s great cities, a common feature of the majority is the existence of a dense core of office space in or near the centre of each city. That office space accommodates global firms, domestic and non-domestic, many of which are international finance firms banks, insurance companies, pension funds, hedge funds, private equity funds, wealth managers and real estate companies or are business and professional service firms whose work is linked to global capital flows. From time to time, these office markets undergo a dramatic transformation old buildings are demolished, new larger, higher specification buildings, often designed by signature architects, are constructed; the core office area spills out into surrounding neighbourhoods, displacing other activities. From time to time, these office markets undergo crises: overbuilding creates an oversupply of space, vacancy rates rise, rents and capital values fall, real estate firms fail. Such crises are often linked to financial market crises and, crucially, often occur simultaneously in cities spread geographically across the regions of the world. Towers of Capital explores the relationship between the evolution of major international financial centres (IFCs) as part of the global capital market system, the development of office markets in those cities, real estate investment in those office markets and the patterns of risk and return that result from the interactions between financial flows and office markets. Each of these aspects has, individually, been the subject of considerable research from a variety of academic traditions. Here, rather than focusing on just one single aspect of the relationship and conducting micro-analysis, an attempt is made to set out the interconnections between the location of financial activity, the processes operating in office markets and the volatility of real estate returns. The intention is to create a schematic model of risk in IFC office markets that can act as a springboard for subsequent empirical work. The essential thesis examined here starts from the increasing spatial clustering of global financial business. The concentration of financial activity in a small number of major cities, acting as the coordinating centres for an interlinked international financial system has been accompanied by a redevelopment of the core office markets of those cities and a growing functional specialisation of activity in those offices as high-order financial services and the business and professional service firms that supply them have tended to drive out other users. A consequence of this process has been an interlocking of occupation, ownership and finance: firms that occupy space are the same firms that acquire offices as an investment asset (directly and indirectly) and who provide finance and funding for the creation of new

14 xii Introduction office space. This interlocking creates greater potential volatility in office markets, increasing the amplitude of upswings and downswings. Shocks in international financial markets are transmitted to occupier, investment and property debt markets and can reinforce any tendency to cyclical behaviour. A number of more recent trends have tended to reinforce this potential volatility: notably the growing globalisation of ownership of real estate and innovation in real estate investment vehicles and debt markets which has fragmented ownership without necessarily diversifying away risk at the overall market level. Aspects of the underlying idea here were sketched out more than 15 years ago in Lizieri (1991, 1992); developed in Lizieri and Finlay (1995) and, more fully, in Lizieri et al. (2000a). The idea of a linkage between real estate and shifts in global financial markets and on the importance of real estate processes and real estate finance in understanding the transformation of world cities is also present to an extent in, for example, Leitner (1994), Fainstein (1993) and Haila (1997). However, over the last two decades, urban research seems to have veered away from a holistic focus on urban development, driven by the apparently increasing gulf between urban social science approaches and those of real estate and urban economics. In particular, the cultural turn in urban geography and urban social science has seen a drift away from critical empirical work to a focus on the symbolic and political implications of urban form and a mode of analysis which often produces opaque, esoteric work that is inaccessible to outsiders. Much of the research in this tradition seems to have moved very far away from the policy-driven critical urban social science that underpinned the early development of the world cities literature and the analyses of urban development processes in the 1980s and early 1990s. From this perspective, traditional urban economic approaches are dismissed for economism and reductionism, generally using a caricature of economic research. In terms of method, the cultural turn has brought an emphasis on textual analysis and small scale interview work, and a focus on individuals with a consequent rejection of aggregate level analysis. Even where the urban social science focus has returned to economic processes in global cities, there seems a reluctance to deal with real estate processes at anything other than a superficial level. Commentators note the production of real estate in global cities, they note its symbolic importance, they discuss the politics of urban planning but, with few exceptions, they do not address the production and exchange of that space in sufficient depth as to suggest an understanding of actual processes and the implications of those processes. As an example, Doreen Massey s recent World City 1 presents a powerful critique of much of the global city debate in relation to London, to social inequality and to the relationships between London and 1 Massey (2007).

15 Introduction xiii the UK regions. She does deal with real estate: it is these land and property interests that have been the vital mechanism in the concentration of investment in commercial building in the prime central areas of cities and into the central cities such as London (Massey, 2007, p. 48). But there is no further analysis she talks of financial land ownership citing her own work from fully 30 years ago (Massey & Catalano, 1978), there are a handful of references to urban geography articles from the late 1980s or early 1990s and a brief discussion of real estate values and property taxes. As with Sassen (1991) she emphasises that a world city must produce the means by which command and control of the world economy can take place which must include office space. Yet there is almost nothing about the mechanisms by which this takes place, no consideration that these might change over time with consequences for the development of a global urban system and risks within that system. To a large extent, the motivation for this book comes from a frustration about this neglect of the key role played by real estate and by a superficial view of property that ignores change over time and the importance of market structures in determining spatial outcomes in the office markets of cities in different countries and regions. I wanted to try to explore the processes that operate in major office markets and the dynamics of those markets in more depth because it seems to me that we cannot truly understand the forces that shape the city unless we have that depth of understanding. That exercise requires a blending of the wider insights of urban social science, international economics and finance with the more detailed focus on microlevel processes found in real estate and urban economics research, for all the methodological differences that exist between these different literatures and disciplines. There are similar frustrations in drawing on the real estate economics literature. Increasingly, the leading journals in the field publish work that is highly quantitative, using theoretical micro-economic modelling and empirical econometric analysis. Wider explanatory frameworks can be squeezed out in the focus on technique. For example, the drive to more advanced quantitative techniques has led to a focus on analysis of public real estate company returns. A number of papers have examined global or regional integration issues. 2 Results typically show the existence of a global real estate factor, some convergence, but less integration than national equity indices. Investment in REITs and property companies is, in the long run, a real estate investment, but the results of such analyses tell us little about actual investment in real estate and the extent to which building performance is affected 2 See, for example, papers by Eichholtz and co-workers (e.g. Eichholtz et al., 1998), Quan and Titman (1999), Ling and Naranjo (2002), Bond et al. (2003) and McAllister and Lizieri (2006).