UK commercial property: preparing for a recovery?
The UK commercial property sector has had a rough time over the last couple of years. By the end of the first half of 2009, property values had fallen over 40% from their 2007 peak (source: IPD Quarterly Index). All is not doom and gloom - as a number of factors have recently contributed to an improvement in sentiment towards the sector.
The UK commercial property sector is clearly on the road to recovery, the question is how long will this run continue?
Drivers of improved sentiment
The improved sentiment towards the sector saw net inflows into property unit trusts double in September 2009 relative to August 2009 (source: Investment Management Association October 2009). What has driven this improved sentiment?
The primary driver has been the enhanced income yield available from property, following the fall in values. This summer, the income from commercial property was at its highest point relative to gilts, bonds issued by the government to raise public funds which are considered a risk-free rate, since 1946.
This income, combined with the high likelihood of capital value growth that typically follows such a downturn in the market, has attracted a considerable investment. Overseas investors have also joined this chase for prime stock, with the further attraction of the weak pound.
In the third quarter of 2009, a number of major investment companies in UK commercial property were able to either restructure their current debt or, through rights issues, increase their capital base. These recent increases have fed through into a pickup in the volume of space let to tenants, particularly in the office and industrial sector.
This has been supported by improvements in key economic forecasts. As we identified in our global recovery vodcast, the tide of pessimism towards the state of the economy has turned. These recent increases have fed through into a pickup in the volume of space let to tenants, particularly in the office and industrial sector.
Further promising signs can be taken from Legal & General Investment Management’s (LGIM's) projections for the Financial and Business Services (F&BS) sector. The F&BS sector, a key driver of growth in the commercial office space, is expected to grow by 2% in 2010, rising to 6% by 2014. This is stronger than the forecasted growth of the UK economy as a whole.
A growth in property values, in addition to the relatively high income return, has contributed to a 3.4% total return for the third quarter in 2009 (Source: IPD Quarterly Index), the first positive return since 2007.
It’s not all good news
Unfortunately, it’s not all good news for the economy and the UK commercial property sector.
Vacancy levels within the UK commercial property sector are still above average. These relatively low levels of occupancy have enabled tenants to negotiate reduced terms and current tight lending conditions are further hampering tenancy rates.
On the economic front, the recovery is expected to be a relatively slow process, which may be further affected by the fallout from Dubai.
Unemployment is still at a 14 year high with no signs of an immediate recovery and the current level of public spending is widely expected to lead to tax rises. These factors will likely hold back economic growth in 2010, and present risks to the commercial property market for 2010 and 2011 that should not be overlooked.
Summary
Rob Martin, Head of Research for the Property team at LGIM concludes: “The continuing challenges in the occupiers markets reinforce the need for highly selective stock picking. A measured approach to increasing property exposures is key, with a strong focus on rigorous asset selection."
Past performance is not a guide to future performance.
The views expressed in this newsletter are those of Legal & General (Portfolio Management Services) Limited and LGIM, who may or may not have acted upon them
