Commercial developers are entering the market and giving their residential counterparts a run for their money


It used to be the case that commercial and residential developers were two quite different beasts. Broadly speaking, big commercial developers looked to build to high specifications, building the properties to own them and rent them to blue-chip clients. Meanwhile their residential counterparts focused on building properties quickly to sell on, retaining no long-term interest.

But the difficulty of funding large commercial projects, a changing workforce and an ever-increasing demand for housing, has meant that the distinction between the two is blurring, as office developers look to expand their repertoires and cash in on the mounting overseas interest in luxury residential properties as an investment. So how radical is this shift, and what issues does it create for the developers and their construction supply chain having to learn a whole set of new skills?

The move to residential schemes by commercial developers is being driven by the global financial downturn, and the resulting desire from many of the world’s richest to find a secure place to store wealth. This phenomenon is most evident in central London with new residential developments springing up in traditionally commercial locations such as London’s West End and even the City, as well as some suburbs where planners had previously looked to increase their commercial potential.

Even in the depths of the recession demand for luxurious homes never slackened, with developments like CPC’s One Hyde Park, and the residential element in the Shard prime examples of this high-end market.

The latest figures from Savills show that while the land values for London office development fell by 2.9% in the year to March 2012, residential land values increased by 3.9%. Overseas investors now make up about 65% of the market for those residential properties costing more than £5m, according to a survey by Savills, with residential properties in the City selling for between £650 and £1,350 per ft2.

So it is hardly surprising some of the biggest names in commercial property are moving into building homes. They include Helical Bar which has 1,700 residential units at the planning stage in the City, Hammersmith and White City. British Land - whose portfolio is largely made up of offices and shops - is developing the 500,000ft2 North East Quadrant in London which includes the 126,000ft2 Triton Tower residential scheme, and has a 70,000ft2 residential-led pipeline worth £94m. It is also reportedly in talks to buy a 200,000ft2 block in Mayfair that has permission to be developed into luxury homes and offices, for more than £150m. In its most recent results British Land has stated that it is looking to “take advantage of opportunities to add incremental value in areas such as residential”.

In the City of London Gerald Ronson’s Heron Group, which has just built the prime office Heron Tower, is now constructing The Heron, a 36-storey tower with 285 flats next door to the Barbican. So far, 80% of the apartments have been sold, priced from £495,000 for a one-bedroom flat to £3.25m.

Traditional housebuilders are still building, but with the exception of London, they tend to be concentrating on out-of-town and leaving urban areas alone

Chris Brown, Igloo

Other traditional commercial developers including Land Securities - with Kingsgate House, the Victoria Circle and Portland House - and Derwent London are acquiring bigger and bigger residential development pipelines. And Argent, whose focus is on city centre development, is reporting that increasingly it too is looking at residential.

Roger Madelin, chief executive of Argent Group, says: “I said in 2000 that by the end of that decade we would be building as much residential as commercial and we were - although it wasn’t a huge amount of either for obvious reasons. The change has been that now commercial developers, when they do go into residential are looking at urban areas and are as good as, if not better than, [traditional residential developers], at building high-quality on confined sites.”

Chris Brown, chief executive of Igloo Regeneration, says he expects the trend to continue for several years, as many traditional housebuilders are having difficulty funding capital-intensive high-rise schemes in the current market, leaving commercial players with an opportunity to move in. He says: “The division between where people work and where people live is becoming much smaller, and the people who can have the competitive advantage are those who can raise the capital - which tends to be the bigger names.

“Housebuilders are concentrating on lower rise developments, and sometimes whole new places, whereas commercial developers are looking at a mixture of commercial and residential developments, sometimes mixed use and sometimes not.

“Traditional housebuilders are still building, but with the exception of London, they tend to be concentrating on out-of-town and leaving urban areas alone.”

Planning obstacles

Getting planning permission for new residential schemes can be a challenge for developers that aren’t experienced in this market, particularly when coming up against resistance from local boroughs keen to retain employment space.

Peter Rees, head of planning at the City of London Corporation, says the corporation will mount a robust defence against excessive residential development. The corporation has already implemented planning policies which are biased against residential developments. “The world has changed,” he admits. “I can understand why it’s happening because foreign investors don’t want their money in cash; they want to put it in something. And even though London has of course been affected by the financial downturn, residential is seen as the least worst option.

“We will resist changes in the City towards residential development and hotels otherwise we will become just like any other part of London. We do have 10,000 residents, but we have to prioritise our 350,000 workers. It’s extremely important that London keeps an area that is business focused, run politically with a business focus.”

We will resist changes in the City towards residential development and hotels otherwise we will become just like any other part of London

Peter Rees, City of London

Thrown into the mix is the continuing lack of clarity over the government’s pledge to allow developers to turn office space into residential use without the need for planning permission. After promising the change, the government earlier this year seemed to back track, saying that changes of use would require planning permission after all.

But last month communities secretary Eric Pickles said the government would introduce permitted development rights to enable change of use from commercial to residential purpose after all, but with the proviso councils have the opportunity to seek an exemption where they believe there will be an adverse impact.

And at the same time other local planning authorities, far from preventing commercial developers moving over, are actually supporting the trend. Donal McCabe, director of corporate communications at Land Securities, says many boroughs are requiring homes to be built before planning permission is granted for office developments. “If you want to develop in London, you have to include residential. To say we have been pushed might be extreme, but ultimately it’s become part of the process,” he says.

A different skills set

So how are developers coping with the shift? Neill Morrison, consultant and quantity surveyor for Deloitte, says it is by sticking to projects that are as close to commercial schemes as possible. This means high-end residential properties are most likely to attract them, as the traditional residential developers have the edge on large developments for the general market.

Morrison says: “Commercial developers will graduate to sites that will use their expertise rather than go for green belt sites where developers such as Berkeley will be doing what they normally do [mass building and quick selling].

“Commercial developers are less likely to compete with established players in their own fields - those who have developed supply chains and understand how to build cheaply. Instead they have more opportunities in high-end developments which don’t come around as often and need to go through more lengthy and complicated planning procedures, something which they are more used to.”

It means learning some new skills. Gerard Cook, partner at recently formed consultant Core Five, says it is a “very steep learning curve” for these companies - for example, in realising that procurement has to be approached in a totally different way. “In commercial schemes you go to the market at a much earlier design stage, because you’re essentially just building a shell, and you don’t need all the detail. With residential schemes you need far more detail before you speak to the contractors, because you’re selling the quality and style of the fittings.”

Cook says some developers have got into trouble by underestimating the complexity of residential schemes. “It can be very complex because you have a lot of different trades going in at the same time, and you have to deal very carefully with that interface. In addition there’s still a cultural difference in the some of the trades in the supply chain for volume build residential.” Some are dealing with this learning curve by bringing in extra consultant advice.

It might be that the trend towards residential will continue only as long as commercial developers find themselves struggling in economically challenging times. However, for others the shift is a permanent one and Cook says many of these are building sizable in-house teams to deal with the new work.
Argent’s Madelin argues that in a wider sense the shift has been positive for mainstream housebuilders too. He says: “For all the horrors of the recession, there has been some good to come out of it for the industry.

“We’ve all had to think about the right way to do things and far from crowding out traditional residential developers, there should be room for more players if you look at the government and the mayor’s [housebuilding] targets. What we need now is for planning restrictions to be eased and economic initiatives to be put into place.”

CASE STUDY: Land Securities in Victoria

Land Securities has been investing in London’s Victoria since the sixties and while its developments have been traditionally commercial, it is now building 200 homes in the district, an area dominated by shops, offices and government buildings.

A major part of the overall development is The Victoria Circle project which is the latest stage of Land Securities redevelopment of Victoria, which also includes the construction of 59 luxury flats at Wellington House and two office schemes.

The Victoria Circle development will comprise five new buildings occupying the island site opposite Victoria Station. The earliest the first phase and the final two phases will be delivered are 2016 and 2018 respectively. When complete, it will provide a 910,000ft2 mix of residential, offices, retail, and public amenities with an estimated value in excess of £1bn.

In addition the Kingsgate House, on Victoria Street, designed by Lynch Architects, will have two new buildings including 102 flats. The public realm will be extended, and include a courtyard bordered by shops and restaurants.

And Land Securities announced in January 2010 that it would start work at Wellington House where 58 of the 59 apartments have now been pre-sold.
Cardinal Place, also in Victoria and which holds the UK offices of Microsoft, is one of the company’s most valuable assets.

Donal McCabe from Land Securities says: “In Victoria, Westminster insists on it [residential to be part of a scheme], in the City it’s a different matter. Residential will always be a very small part of our portfolio, but it has to be there now. What we are doing is making a virtue out of necessity.”