Commercial Insurance Articles
UK Commercial Property Market Outlook 2007: Is there trouble ahead
06 Jul 2007
Recent years have seen buoyant performance from the UK commercial property sector, with impressive returns on rental yields and resales.
However, economic factors and rising prices are cutting into these positives for the market and leading to some investors turning to overseas property for better deals.
Nucleus Global Investment is one such fund which has chosen to drop its British property investments in favour of markets in Europe, as well as India. This move has seen around eight or nine per cent of the fund's £56 million warchest being thrown into opportunities on the continent, whereas before the UK commercial sector would have been the target.
Explaining the company's decision in June, James Burn, the trust manager of Nucleus, described the UK commercial market as being "at the top end of the cycle" and said this meant that "it made sense to diversify" in the properties managed by the fund.
But what has led to the swing against commercial property in the UK? After all, demand still remains high from businesses looking to rent while more properties are hitting the market through new development.
But Francis Salway, the chief executive of Britain's largest property company Land Securities, recently warned of a significant slowing in price rises in the UK's £710 billion commercial property market.
According to Mr Salway, some "pockets" of sub-prime retail commercial property have been experiencing falling prices for as long as between six and nine months.
And this slowdown in price inflation has spread across the board after it was greatly exacerbated by the series of interest rate hikes which have come into force since last year.
Continuing uncertainty about what the future holds for the Bank of England base rate has seemingly damaged some investors' confidence in the market, while they have been hit in the wallet as rates increased to 5.5 per cent.
And property advisor Savills has more recently predicted that "possible further increases in interest rates in the UK will continue to affect commercial property values" while other markets such as prime residential will be much less affected.
There are growing signs that these increases will go ahead in the next few months, according to Bloomberg, with David Page, an economist for Investec Securities, telling the finance website that the governor of the Bank of England, Mervyn King, was "clearly uncomfortable" with leaving rates as they are, due to his view that there is still a need to take action to bring inflation down to its two per cent target.
Such is the effect of these higher interest rates in making property yields far less attractive, that it has reached the point where they are now outpaced in the UK by bond yields.
The gloomy predictions for commercial property are being further reinforced by perceptions among some analysts that there is an oversupply of new commercial property being brought to the market, outstripping the level of demand in some areas.
Tim Wheeler, the chief executive of Brixton Estates, one of Britain's largest industrial landlords, recently explained the company's decision to withdraw from parts of the UK warehouse sector outside of London by suggesting that oversupply could lead to price falls.
He said: "This [industrial sector] supply imbalance and lack of market transactional evidence will lead to underperformance and potentially falling values."
London and the south-east remains strong, however, and is preparing to absorb huge increases in office space through developments such as British Land's Leadenhall Building which will be complete in 2011.
Commenting on the possibility that the market may have swung against constructors come the completion date, British Land's chief executive Stephen Hester said: "It is impossible to tell. There could be risks from supply. But the risks are always on our side in the long term.
"I'm not saying the market will be great in 2011, but our building will be the best available in that year. Our job is to know how to add value."
However outside of London and the south-east, investors being affected by falling yields are being tempted by Europe's emerging markets which have offered an ideal get-out for companies willing to cut-and-run from the UK commercial sector.
According to Savills: "Demand for prime commercial property across Europe remained strong in the first half of 2007, although investors are becoming increasingly selective, focusing on strong opportunities for upward rental growth."
However, some investors may find themselves pushed before they can jump - and not just to European property but out of the commercial market completely if, as Quintain Estates and Development predicts, repossessions leap due to owners struggling to cope with interest rate increases.
"My best guess is there will be some repossessions," said Quintain's chief executive Adrian Wyatt.
"Over the past few years there have been a number of highly geared private investors. Repossessions by banks have started to increase. Is that a bellweather of the commercial property market? Arguably yes. There is a major risk out there for refinancing."
Mr Wyatt suggested that the four-year, high-performing bull market in commercial property is coming to an end, however established companies may profit from cheap purchases as some owners are turned into forced sellers by repossession.
Such an accumulation of downbeat opinion does not suggest a rosy outlook for commercial property, yet despite this Savills says some residential property investors are using that market as a "stepping stone" to enter the commercial sector, with few individual landlords heading the other way showing that some still hold faith in the market.
And with good reason as predictions suggest that, while there has been a drop in returns on commercial property from 18 per cent in 2006, investors will record a respectable eight or ten per cent return this year.
