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UK commercial property
Robert Walters, investment director - property.
September 2009 review
Much has been written of the carnage that has befallen UK commercial property values over the past two years, in the wake of a near 50 per cent decline in capital values. At present an almost equal amount is hailing 'the turn' and predicting a recovery, but is it as simple as that? In a post Lehman, post credit crunch world, is it reasonable to expect UK commercial values to return to the heady heights of early 2007 and, if so, when will they get there?
Property, perhaps more so than many other asset classes, the absence of a single unified market makes such predictions notoriously difficult. However, there are many leading indicators which may give rise to an outbreak of mild optimism.
Commercial property values are driven primarily by income, and as capital values have been pushed down due largely to market sentiment, yields have correspondingly risen to levels not seen for many years. An alternative way of considering this is that the high quality assets which may have become unattractively expensive are now ‘tantalisingly’ priced
Added to this is the fact that the majority of property purchasers use some level of debt to purchase property – which with base rates at such low levels allows for higher 'margins'. This presents investors with a positive yield gap, which had, in 2006, been negative.
The absence to date of a wave of forced sales and foreclosures by the banks, aided by low interest rates and the changing attitude of the institutions, has meant that there is currently a shortage of stock in the market. If the increase in demand from various investors continues, this will only have one effect on prices - up.
Whilst low interest rates are helping to keep existing investors afloat, the weak pound has proved to be a strong attraction to foreign buyers keen to pick off what they now perceive as bargain assets in the UK, especially in London and the South East which has traditionally been a hot spot for overseas investors.
These factors have led to a number of headline grabbing deals, and agents are generally reporting significant activity with many finding it difficult to find good quality stock to meet investor demand.
This may be perceived as a revival, but caution is needed, as this does not appear to be a widespread reversal of fortune - secondary assets are still falling in value (traditionally more likely to be financed by debt) and the majority of buyers are cash only and this may not last indefinitely.
The relatively low yields from other major asset classes adds to the appeal, coupled with the diversification benefit of a physical asset able to offer a consistent income stream and the possibility of real capital growth.
But this is not a call for rushing in – caution is always a worthwhile policy. Despite the hardening of prime yields (i.e. prices going up) and signs of a revival in some markets, rents themselves are under pressure, putting tenants back in the driving seat when negotiating terms. Furthermore, the demand for space is declining and landlords are being forced to lower rents providing significant rent free periods (though this is not always a bad thing as having a good quality tenant on a long term lease can largely offset the downside of not receiving the rent).
Perhaps the bigger problem, compounded by the Government's insistence to maintain 'empty rates', is the impact of being unable to find a tenant.
Offices are notoriously difficult to manage due to fierce competition and the high costs of refurbishment, whilst well located retail is proving of interest due to it having less cost for the owner.
Overall, logistics/distribution and retail warehouse are proving to be the ‘deal of the day’ amongst many investors; at least those with high yields from long leases let to strong multi national tenants. Many investors crave income and whilst rental growth may not be available for a few years, investors can take some comfort from the UK lease structure which, as long as they have faith in the covenant of the tenant, offers some protection from falling rents.
The investment market shows signs of improvement and, perhaps, the combined effect of these indicators will be shown to be 'the turn' in the market. Equally, should the decline in rental values and occupier risk intensify then this could become what has been coined a 'double dip'.
That said, the improvement in sentiment and increasing amount of available capital to invest could become a self fulfilling prophecy.
Ultimately, when a recovery in values does come, without the huge amount of debt previously available that recovery is unlikely to be as steep as the recent past. However, the income opportunity is compelling.
With potential opportunities becoming available, it is the quality of the management team, strategy and potential portfolio income that should prove the determining factors when deciding whether to invest.
Last updated: 22/12/2009 17:31:41
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Market Views And Commentary: UK commercial property
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