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Government cuts to cripple property firms

The Telegraph Newspaper via Google

Government cuts to cripple property firms

The Comprehensive Spending Review may decimate rental income as the Coalition prepares to cut office space and more effectively use state assets.

It would take more than 230 replicas of the Gherkin skyscraper to accommodate the Government's existing office space

It would take more than 230 replicas of the Gherkin skyscraper to accommodate the Government's existing office space. Imagine the cost of constructing those skyscrapers. Then imagine that 25pc of them fall empty. The loss of rental income would leave the developer with a crippling hole in his finances and, given the economic downturn, a fierce battle to find replacements.

In an exaggerated sense, that is the predicament looming for the commercial property market as the Comprehensive Spending Review approaches.

The Government's cost-cutting is already closing quangos and reducing the workforce, which inevitably leads to a fall in required office space. The Government is also preparing to increase the efficiency of its property portfolio, which includes rented and directly-owned assets, as a cornerstone of plans to cut the UK's budget deficit by £83bn.

Commercial property companies in London are bullish about the threat. Not only do they believe that the Government will look to retain most of its holdings in the capital but that where they do exit will present redevelopment opportunities into a supply-constrained market. The real strain threatens to be in the regions.

"The Government is facing the challenge that the private sector has over the last two years," says Matthew Stone, director of occupier strategy at Cushman & Wakefield, who advised Wolseley, the building materials group which has cut thousands of jobs, on its exit from 170 lease liabilities earlier this year. "However, if the Government is the predominant occupier in a region and effectively dumps space, it is going to decimate rental values."

Data on the Government's property holdings is inconsistent and fragmented but perhaps the most thorough and respected research is the Office of Government Commerce's (OGC) State of the Estate. It shows, as at the end of 2009, that the Government occupied 115m sq ft of offices, with around 35pc in London and the South East and 12.5pc in the North West, the equivalent of 14 Gherkins in Manchester.

About 38pc of the office space is owned, 33pc is held through the Private Finance Initiative (PFI) and 29pc is rented. The cost of running the estate is £3.47bn a year and the property assets owned by the state are worth £350bn.

Efforts to make savings and raise capital are already under way. Last week, David Cameron wrote to departments urging them to focus on property sales and savings as, delivering his report on public sector efficiency, Sir Philip Green lampooned the Government's management of its property empire, calling for a centralised body.

Involving the Arcadia boss is in itself a reason to make landlords quiver: the retailer is a notoriously tough negotiator with property owners.

Consolidation is expected. In the latest report by the OGC on the estate, it praises the efficiency of Communities and Local Government, which, "for the first time in its history", has all of its 2,300 central London staff in one building, the gleaming Eland House. This was achieved through having only eight desks for every 10 staff and agreeing a lease break deal with its landlord, Land Securities, on Ashdown House.

Under John McCready, who was appointed late last year as the Government's property tsar, such consolidation is being sought on a grander scale. A five-year moratorium on rents has already been imposed and this week, patek philippe replica watches in the CSR, it is understood he could be told to seek property sales of up to £25bn and to cut costs by 10pc.

Industry sources say McCready is planning a new central property vehicle for the Government's London and Bristol office estates. It will take control of the portfolios from departments and seek private sector involvement, possibly through asset management contracts with outsourcers such as Telereal Trillum.

On his appointment, McCready also spoke of potentially spinning off government assets into Real Estate Investment Trusts, or seeking to redevelop sites with a private partner.

His task though is laced with difficulties. If the Government wants to sell assets it will have to do so into a market where office capital values remain more than 25pc down on the peaks of 2007.

In terms of exiting rental deals, the Government will be unable to walk away from contracts, given the cost the landlord will demand, and it risks a political backlash in regions where rental values are too fragile to withstand the loss of the main tenant.

Commercial property sources are already warning that retailers are rethinking moves to areas where the public sector is prominent. A paper from GVA Grimley, the consultancy, says: "The types and locations of sites that become available will not appeal to private sector investors and increased supply relative to weak demand will push asset prices even lower."

The state property revolution, therefore, could exacerbate a growing polarization between prime and secondary assets, and London and the rest of the UK, something Gerald Ronson said earlier this year could cause "social unrest". Whereas the Government accounts for about 5pc of office demand in Central London, it is thought to be 40pc in cities such as Newcastle.

London commerical property owners may find themselves in an enviable position compared with the owners of secondary government offices in Manchester, Newcastle, Wales and Scotland. Not only are their "Gherkins" more likely to fall empty but their property is a world away from the quality, prestige and youth of the London skyscraper. Finding replacement tenants will not be easy.

The Government used to be considered a rock-solid rental deal, one whose reliability was worth promoting to potential investors and celebrating in communities. The CSR is set to herald a new era.