2010 - A Rocky Road Ahead

8th January 2010

The Noughties was a decade of marked contrasts, which saw stock markets decline as the FTSE 100 fell by 21% (approximately 35% in real terms) and house prices rise 91% overall, according to Halifax.

2009 showed similar conflicting trends, with plummeting total returns in the early months in all sectors, but ending with the FTSE 100 up 22% on the year. Residential values managed an overall increase of 5.9% according to Nationwide, but with extremes of 7% gains in London and 2% drops in the North.

Commercial property investment values, reported to have declined by circa 45% since the 2007 peak, saw a remarkable turnaround. This was especially true at the prime end of the market, with yields declining in some cases by more than 150 basis points, leading to capital value rises of circa 25%, since a low in March 2009.

The return of institutional liquidity and diverse range of overseas investors attracted to London by the fall in sterling, added to the well-documented private and opportunity-based money ready and waiting to buy bargains. The addition of quantitative easing policies, and lack of prime property for sale, led to an inevitable jump in prices in this sector, with a scramble by institutions to close deals by the year end.

2010 should see continued upward momentum, especially for prime properties let to strong tenants on long unexpired leases with fixed rental uplifts.

However, traditional fundamentals for commercial property investment remain poor, with weak tenant markets and continued fall in rental levels. Secondary stock will continue to languish.

The few occupier market bright spots include Central London offices, where supply constraints could force rents up slightly, and convenience and value retailing that is diversifying and expanding.

Whilst a gulf has opened up between prime and secondary property investment pricing, there could soon be a return to more overall conservative pricing and dealing as 2010 wears on, due to the broader complexities and uncertainties of world economics and politics.

The reality of managing massive national debt, sustained high levels of unemployment, reduced public spending, tax rises, and a reversal of government stimuli have yet to be felt. There are already signs, reflected in rising gilt yields, of general investor nervousness relating to the direction of future pricing.

With an estimated £250 billion of commercial property debt in the UK (according to the Bank of England), much of which is in default, and an estimated £160 billion of loans due to mature in the period to 2013, many investors and banks will be focused on refinancing and legacy issues. This should, over the next two years, result in increased supply of stock as banks eventually decide to crystallize losses.

In 2010, the challenge for investors will be to seek out the relatively small number of growth opportunities that will become available at sensible pricing levels.

We believe the growth opportunities will be largely limited to markets with tight supply in Central London and the South East, dominant retail locations, and those one-off opportunities with restructuring or refurbishment potential that are in a balanced micro market.