Commercial property investors in the U.K, battered by more than two years of price declines, are likely to get relief in 2010. It may be short-lived.
Values of stores, offices and warehouses will rise 7 percent this year, according to the median estimate of 10 fund managers overseeing 65 billion pounds ($105 billion) of buildings in the U.K. Predictions ranged from a gain of as much as 15 percent to a 19 percent decline.
The global financial crisis pushed Britain into its longest recession on record, driving property values down by 44 percent from a mid-2007 peak, boosting vacancies and depressing rents. While lower values have revived investment demand, price increases may not last beyond the first half as lackluster economic growth forces tenants to cut jobs and demand rent reductions.
“We’ve gone from Armageddon to a frothy investment boom in the space of a year,” said Sabina Kalyan, a London-based senior director of European strategy at CBRE Investors, a unit of CB Richard Ellis Group Inc. “Property was priced historically cheaply and has gone from being a no-brainer to fair value.”
The price slump lifted average rental income to 7.9 percent of commercial building values, the highest in 12 years. The ratio, known as the capitalization rate, exceeded the yield of 10-year U.K. government bonds by 4.3 percentage points on June 30, prompting investors to move money into real estate.
That margin is currently the widest Standard Life Investments has seen in 80 years of tracking, said Anne Breen, the asset manager’s head of property research.
Prices Rise
Selling prices began to rise after bottoming out in March. Appraisers marked up commercial real estate for the first time in 25 months in August, and by November properties were appreciating at their fastest monthly rate in 15 years. Values in November were still 14 percent lower than a year earlier.
“We could quite easily see total returns rising 20 percent if the market gets carried away,” said Mark Long, a director of investment strategy and research at Invista Real Estate Investment Management Plc. For now, “it’s a return to fair value after an overcorrection,” he said.
Investment in U.K. commercial property increased by 10 percent in 2009 to 23 billion pounds, according to estimates by commercial broker Jones Lang LaSalle Inc. That’s 34 percent less than the average for the past decade and compares with the record 63 billion pounds of deals completed in 2006.
Commercial real-estate mutual funds had their first net inflows of money in 25 months in June and have climbed each month since then. Real estate companies raised 6.3 billion pounds this year from share sales.
Foreigners Attracted
Overseas investors spent more on U.K. commercial property after the market became one of the first to recover from a global slump. The pound’s 23 percent decline against a basket of currencies since mid-2007 added to the market’s appeal.
Canada Pension Plan Investment Board and London-based Hammerson Plc bought Silverburn shopping center near Glasgow for 297 million pounds in a transaction announced on Dec. 21. They said the property generates annual rental income equal to 6 percent of the purchase price, rising to 6.8 percent once rents are raised to market rates.
The combination of rising prices and falling rents will reduce the capitalization rate, giving investors less reason to risk their money on real estate. The rate fell 60 basis points to 7.3 percent from June to November, Investment Property Databank Ltd. said. A basis point is 0.01 of a percentage point. Cushman & Wakefield LLP estimates rates in prime property deals fell by twice as much since March.
‘Easy Buying’ Over
“The period of easy buying is over,” said Robin Goodchild, head of European strategy at LaSalle Investment Management. “We’ve switched from being an aggressive buyer to taking our foot off the accelerator,” he said.
The unit of Jones Lang LaSalle sold the Wren Retail Park in Torquay, southwest England, Dec. 21 to Aviva Investors Pensions Ltd. for 24.4 million pounds, or a capitalization rate of 5.5 percent.
All the asset managers in the survey predicted, to varying degrees, a repeat of the “double dip” that Britain’s commercial property market experienced in the 1990s. After a three-and-one-half-year slide to mid-1993, prices rallied for 12 months before falling again through 1996.
“The quicker the market moves up over the next three to four months, the greater the risk of over-exuberance and a fallback in values,” said Andrew Smith, chief investment officer at Aberdeen Property Investors.
Bleak Economy
The price increases aren’t backed by any comparable improvements in the U.K. economy, the managers said. Rising unemployment and prospects of weak growth after the recession will probably weigh on values from the second half of this year and into 2011, they said. Particularly vulnerable are buildings in out-of-the-way locations, in poor condition or with tenants that are struggling financially.
“There’s not much good news around the corner, with a major squeeze on public finances, a debt overhang and the consumer nailed with higher taxes,” said William Hill, head of property at Schroder Property Investment Management.
Predictions by the fund managers assume the Bank of England will probably keep interest rates near historic lows this year. They also expect that banks, which hold more than 250 billion pounds of commercial real estate loans, won’t flood the market with properties from foreclosure sales.
Banks would have to sell 100 billion pounds of buildings to bring their real estate loans back down to their long-term average levels, Standard Life estimates. That amount equals three years of average commercial property sales in the U.K. during the past decade, according to Jones Lang LaSalle data.
Bank Power
“The influence of the banks over the next five to seven years will damp strong, visible capital growth,” said Bill Hughes, managing director of Legal & General Property, a unit of the U.K.’s second-biggest insurer Legal & General Group Plc. “That means uninspiring returns.”
Investors must focus on getting the highest and most secure rental income to bolster profits rather than selling buildings, as gains in value will be limited, the fund managers said.
Strategies for maximizing rental values include buying properties in distress sales, choosing buildings where leases expire at a time when rents are likely to have improved, focusing on new construction or renovating properties in markets that have a supply shortage.
“It’s going to be a bumpy ride,” said Alex Watt, Standard Life’s managing director for property investments. “The market may come off in the second half of 2010, but there are real opportunities out there too.”
Source: Simon Packard (2010). U.K. Commercial Property Investors to Get Price Relief in 2010. Bloomberg Published Jan 07, 2010 Viewed Jan 08, 2010, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aLsp1cwc4sOg
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