July 09 - Floor or Shelf?

We are at an intriguing stage in the market cycle. We have noticed increased activity in the past few months in secure well let product and also in quality multi-let industrial investments. Many are calling the bottom of the market and either acquiring investment property or pulling together the funds to embark on an acquisition campaign just as soon as possible.

Floor - They consider that investment yields have moved out just about as far as they can and are frustrated by the low returns receivable from cash deposits and nervous about the volatility of the equities and gilts markets. Furthermore the weakening pound against the dollar and the euro has increased activity for foreign investors. Overseas investors accounted for 43% of overall UK purchases during the 2nd quarter of 2009 (LSH UKIT Investment Activity Report). Much of this was directed to the London office market despite general expectations of significant further falls in rental levels.

Shelf - There is however a body of investors who are still sitting tight. Whilst capital values have fallen approximately 43% from their peak in July 2007 forecasters are generally anticipating that this will move out to approximately 54%. Furthermore the derivatives markets (whilst softening the position slightly) still anticipate capital values to fall by a total of around 59% from their peak.

This would of course suggest that investors should hold on a little longer until the market reaches the very nadir of its cycle. Whilst investment yields have moved out perhaps just about as far as they might, it is expected that falling rental values and increasing voids will be the causes of the further anticipated attrition in property values. This is borne out by the latest IPD monthly index (June 2009) which identifies this as the first month (of 24 consecutive months of falling values) in which falling occupier demand, rather than outward movement in yields, played the lead role in driving capital decline.

Opinion
Our own view is that the forecasters have generally got it right this time. However the overall statistics do not reveal the differing circumstances within various sub-markets of commercial property investment. There is evidence that prime, securely let products have reached capital values as low as they are likely to go, particularly if there is limited fear of over-renting. We are witnessing a greater polarisation between prime and secondary and expect that secondary properties could suffer further outward movement in yields which, combined with falling income levels, may hit capital values quite severely.

However we have noticed a significant improvement in interest in multi-let industrials, particularly north of the border. We consider that Scottish multi-let industrials offer one of the best opportunities for investment presently. This is because they offer rental levels which do not look set to suffer the same falls as the retail and office sectors. Furthermore they offer a spread of risk being let to a large number of tenants. Additionally the absence of empty rate liability in Scotland will significantly limit the risk of non-recoverable expenditure for any voids which might appear across an estate. This is already being reflected in the interest shown in some of the better quality estates across the central belt of Scotland. These include Colvilles Park in East Kilbride, a high quality recently completed multi-let development which we have just sold for the Ashtenne Industrial Fund Limited Partnership.

As always the UK property investment market is a blissfully imperfect one, presenting the chance to seek out value in all sectors. Supply though is very thin and we find ourselves delving into regions south of our established comfort zone to seek out these nuggets.

How the market moves over the latter half of 2009 will be of considerable interest. The ability of the larger debt-exposed investors to find solutions to imminent refinancing and the approach of banks - will they continue to work with their borrowers or will they repossess and implement disposal strategies? - will be a significant determining factor in the supply/demand dynamic, and therefore investment property pricing.