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Others may be depressed about the outlook for property but Derwent London’s chief executive exudes laid-back confidence

by Rachel Robson

Leaning back in his chair with his arms folded or stretched behind his head, John Burns, chief executive of Derwent London, certainly looks like he is ready to take on whatever I throw at him.

We are in the chief executive’s office, in the classy area of Mayfair. But Burns, stresses it is the only building the company has in Mayfair, as the group prefers to focus on mid-market rental levels, rather than the more expensive markets of Mayfair or St James’s.

Derwent London is not alone in its focus on the West End. Great Portland Estates and Shaftesbury also operate there. So what makes Derwent London stand out? ‘We all do something differently,’ he replies. ‘From our point of view... we’ve really cut our mark by specialising in tremendous design, spotting value, refurbishing a building, [and] probably, having a vision.’ He adds that the company is prepared to be creative and often sees things others don’t.

Railway journey to property

Burns, 64, is clearly comfortable with being interviewed, something he has no doubt often done since he founded Derwent Valley more than 20 years ago from a shell that, in its former life was a Yorkshire railway operator valued at £1.5 million. Burns built up the group, and last year it merged with London Merchant Securities to become Derwent London. The group’s investment portfolio is over £2.8 billion.

The credit crunch has created many challenges for the property sector, with demand for office space, even in London, starting to decline. The West End is said to be more resilient, but Burns acknowledges it ‘won’t remain totally immune’. However, he points out that with very little space and with 75% covered as a conservation area, there is a bit of insulation from a downturn. So far, he says, demand for lettings has been ‘satisfactory’, although he admits filling the Qube building has been slower than anticipated.

More supply than demand?

Regarding limited space in the West End, I point out that this year around 1.2 million square feet of new space will be completed (according to CB Richard Ellis Market View: Central London Offices Q4 2007). Will this impact supply? ‘That’s not a great amount of space coming on,’ Burns responds, adding that space isn’t really the issue, the underlying economy is the concern. ‘The main thing is to make sure you let your space and you don’t have too much coming available at one time.’

But if Burns really is concerned about the economy, he seems to have adopted a very relaxed ‘wait and see’ attitude.

On rental growth I point out analysts at Citigroup forecast estimated rental value (ERV) declines over the next 12 to 18 months of up to 5% in the West End. They say, if the economy slows considerably, 10%-plus declines in rent cannot be ruled out in the area. Surely this could pose a serious problem?

Again Burns is unfazed, pointing out that the company saw modest rental growth in the first quarter, and that it is now flattening but not declining. When I ask him if he expects to see a decline, he again adopts the same attitude of ‘let’s see what happens with the economy’, adding confidently that of all the places to be, ‘I think we’re in the best’.

Perhaps he is right. Analysts at JPMorgan are forecasting London City offices will experience the most yield outshift, moving out by 160 basis points (bp). In comparison, they only forecast a 70bp yield shift for the West End.

Also, Derwent London benefits from a very strong business model. As Burns puts it, ‘we don’t buy holes in the ground’. Instead, the group’s strategy is to add value to buildings and sites through creative planning, high-quality architectural design and enterprising lease management. In addition, the properties the company buys are let and usually income-producing until the day the group gets on site. For example, the group’s big scheme in the Angel Islington is covered with rental income until 2010 – until the building is almost ready. This means, if necessary, in bleaker market conditions, the group can halt planned development until conditions improve, at the same time rolling the lease on and continuing to collect revenue. In the same way, this means planning permission is less of a problem. ‘We’re under no pressure to get planning because we have got income onstream,’ says Burns. He gives the example of a couple of buildings that were to be emptied this year, but didn’t get planning in time, so they will now be emptied in 2010.

I ask Burns if he is considering putting anything on hold at present given the current outlook. ‘It’s an option we always consider,’ he replies. ‘If we found lettings were going slower,... we probably would just run on the income,’ he adds. ‘It’s a simple business model.’

Large reserves

The company also looks pretty comfortable financially. It is focused on capital recycling, because, as Burns puts it, ‘we don’t believe in hanging on to properties once we’ve done our job.’ The group also has over £300 million of unutilised bank facilities, so it has no need to borrow more money for further developments.

What about real estate investment trusts (Reits), launched in the UK in January 2007? The company converted to Reit status last July. Reits have come up against a lot of media attention over the past year or so, after hype around their launch suddenly flopped, along with company share prices. When I point out that the share price of Reits has been pretty dismal, Burns replies that he doesn’t think Reits themselves have been the issue. ‘I think what happened was property finally, about two years ago, was reassessed as an asset class and we, being the poor relation in the asset class, were recognised, and quite right too.’ He adds defensively: ‘I think what happened was share prices went ahead on values and they were perfectly correct until some values got a little bit toppy. The advent of Reits had nothing to do with it.’

Burns clearly has no regrets about the conversion, pointing out that Reits are much better as a public company because you can attract a wider range of investors and they are more easily understood. Regarding tax savings, the group has already made a capital gains tax saving of £31.3 million on disposals, so Burns seems pretty happy.

We switch our glasses of water for cups of mint tea – a drink I may not be too familiar with, but one that I have to say is pleasantly refreshing and highlights Burns’s laid-back demeanour.

He is obviously confident about the company’s position in the market. So I ask him what he thinks would happen if the property market completely crashed. ‘It would be awful for everyone,’ he acknowledges, but then adds, ‘but we are still in very good shape.’

Slow dancing

I particularly like his expression that it’s important to be ready for such events ‘so that when the music gets slower, you’re not left stationary [and] you can move forward.’

He also points out that the company has faced a downturn before, as the business was built through the 1990s in tough times. ‘We did most of our big buying in ‘93, ‘95 and ‘96,’ he says. So I ask him if that experience is likely to help him this time. ‘I think experience always helps,’ he replies, adding that although in many ways, the company’s property and thinking has been aggressive, ‘we have always run the pure business on very conservative grounds and it’s very sound.’ He also believes that balance sheet gearing is not as important as profit-&-loss (P&L) gearing. ‘P&L gearing is the key,’ he says.

I’m beginning to wonder if Burns was a boy scout because he certainly seems to have adopted the motto ‘be prepared’. But I am also wondering if maybe, having run the business for so long, it’s now time to inject some new blood into the company.

He either misunderstands my meaning or deflects the question, saying the company has a very strong management team with some new people and that has been the secret to success, and is not likely to change any time soon.

The meeting draws to an end, and Burns politely helps me into my jacket. I start to think that maybe, amid the bleak outlook for the property market, it’s not all doom and gloom.

‘I don’t think it’s all over yet,’ says Burns, ‘but we’re ready and we’re in great shape.’

30 second – Derwent London

• Derwent London was formed through the merger of Derwent Valley and London Merchant Securities on 1 February 2007

• John Burns acquired Pilcher Hershman & Partners before he found the ‘shell’ of the Derwent Valley Light Railway Company in 1984 and arranged its restructure

• Derwent London converted to Reit status on 1 July 2007

• Has investment portfolio of over £2.8 billion, of which 93% is in central London

• Refurbishes derelict warehouses and unloved office blocks in London ‘villages’, such as Fitzrovia and Islington

• Landmark schemes include Qube, Johnson Building, Davidson Building and Broadwick House