London’s office investment market will soon start to benefit from a return of capital next year as investors retreat from overseas markets, said BH2 today.

In its report - UK real estate monies into Europe: Sensible diversification or reckless adventurism - the property services company said the ‘apparent superior returns’ overseas, particularly across New Europe, look ‘uncannily like classic yield traps’.

The report predicted a costly retreat for UK investors from overseas, as yields fall across the Eurozone and rise in emerging Europe, back to the London office market which ‘they should never have abandoned in the first place’.

It said that returns overseas, after allowing for currency risk ‘are in fact no higher than UK returns on a risk adjusted basis’ and that for pension and insurance funds, whose ultimate liability is in sterling, investing overseas ‘smacks of dangerous currency mismatch.’

Domino effect

It predicted that the Baltic states would experience a major currency shock next year of ‘at the very least 15% falls against the Euro’. Any crisis in the Baltic markets would impact Sweden as its commercial banks have been some of the most significant providers of capital for Baltic economic growth.

It added that any reversals in the Baltic and Nordic currencies could set off a ‘domino effect’ where ‘currency after currency of New Europe would be expected to come under speculative attacks.’ It said interest rates might have to increase to defend currency pegs and/or to stem the flight of capital.

‘At the first sign of European currency shocks, which we are convinced will detonate in 2008, the London office market could well benefit from the return of capital evacuated form overseas adventures, or as we would like to put it ‘Dunkirk II’,’ said BH2. ‘Indeed, whilst UK investors will one day be able to return to European real estate markets it could be sometime coming, the Normandy landings were after all four years after Dunkirk.’