Is commercial property making a comeback?

By Associate Editor David Stevenson Sep 10, 2010

David Stevenson

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Commercial property prices in Britain are up by almost 17% since last September, according to the Investment Property Databank (IPD) quarterly index. And plenty of upbeat headlines are suggesting this heady growth can continue for the moment. So why aren't we bullish too?

Commercial property prices here are still down by a third from their mid-2007 peak. British real-estate investment trust (REIT) investors will be painfully aware of the serious damage that inflicted on their portfolios.

Britain's commercial property firms turned themselves into REITs at the start of 2007, largely to avoid capital gains and income tax if they pay out most of their income to shareholders. But following the price bubble in 2005 and 2006, the onset of REIT status also marked the top for UK commercial property. Shareholders in quoted REITs have since lost 60% of their money. Despite a bounce from the March 2009 lows, investors in the sector have actually made no capital gains since 1993.

Now, though, "return-hungry investors have spotted the [recent] growth and moved back into commercial property funds", says Simon Read in The Independent, after a "mass exit in 2008 and 2009". Latest Investment Management Association statistics show that in June commercial property was the third most popular sector with investors, jumping from seventh the previous month. It's a pity, then, that the recent price bounce is likely to be as good as it gets. Several forward indicators suggest the next move in commercial property values is likely to be down.

First, the effects of the UK's biggest fiscal tightening since World War II have yet to affect the economy and the high street in particular. That's bound to cause another round of shop closures. Rents and capital values will suffer accordingly. The August Investment Property Forum (IPF) survey suggests capital values will decline next year. Some respondents reckon they will drop by as much as 8% in 2011. What's more, the latest data suggest that British all-property yields (rents as a proportion of prices) will soon start climbing again. But unless rental levels also rise – and the IPF survey indicates a 2010 fall is more likely – such an increase in yields will mean that capital values must drop.

Second, the apparent recovery in Britain's corporate mergers and acquisitions (M&A) activity isn't what it seems. M&A tends to power up future office space demand, which raises rentals. However, although the second quarter's UK M&A deals were almost a third up on last year, 2009's second quarter saw the lowest activity figure, in real terms, on record. Acquisitions by overseas firms in this country actually fell 85% from the first three months. So there's scant hope of a market boost on this front.

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Third, the CIPS/Markit Construction purchasing managers' index, another useful forward measure of all-property rental values, dipped for the third consecutive month in August to a six-month low. This "hints at growing concerns amongst developers about the prospects for economic growth and occupier demand", says Kelvin Davidson at Capital Economics. Despite rallying 15% within the last two months, UK REIT shares are still down in 2010.

So we've looked to a country whose economic prospects look rather better than ours – Germany.

The best bet in a bombed-out sector

We're not too optimistic about the prospects for European commercial property. There's still too much uncertainty about where economies are heading for our liking.

That said, the most appealing market is one that's been in bear mode for many years. In the decade until end-2009, German property prices fell by more than 15%, according to IPD figures. During that time, retail values lost 12%. But the latter held up well during the global recession. Recent data suggest the country's export-led recovery is spreading to domestic demand, which should help push rents and prices higher.


Investing in German property is made perilous by the ultra-high borrowing carried by most quoted property firms. However, European shopping centre owner Deutsche Euroshop (GY: DEQ) is at the low end of the scale, although even here, gearing is 85%. But in contrast to many of its peers, in the decade before last year's recession, Euroshop achieved solid growth in its net asset value.

With around 85% of its revenues and assets in Germany the group is ideally placed to cash in on any domestic retail upturn. On a forecast 2011 p/e of 14.5 and a prospective yield of 4.5%, shareholders are getting value for their money.

• This article was originally published in MoneyWeek magazine issue number 503 on 10 September 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.

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Published in Tips & advice | More articles by David Stevenson

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  • 1. Merdeka

    (14 October 2010, 11:56AM)  Complain about this comment

    Surely the fact that commercial property has 'bombed' was down to people investing in funds rather than the underlying asset. Also a lot depends upon the type of property - small industrial units (similar to owner occupied) might always have demand/value whereas shop premises in arcades are probably more at risk

    In one sense any commercial peoperty is worthless unless tenanted, however, with fund yields of 4.5% (in the good times) then it is simple mathematics. For example, deriving potential asset value by taking £10K rent @ 4.5% = £222,222 whereas a more realistic 7% = £142,857 - a difference of £79,365 - is this where the loss in value has gone?

    So the question should be, have commercial properties found their real level rather than the 'hyped' fund level

  • 2. DC88

    (14 October 2010, 01:26PM)  Complain about this comment

    Why are so many people pessimistic about commercial property?

    Despite having a severe recession the net income yields on REIT's are among the highest available on any asset. A general economic recovery will help rents to raise and property is a hedge against inflation if QE gets out of hand.

    The risks seem to be a double dip recession or the banks calling in the loans secured on the properties. The double dip is certainly a realistic possibility but unless you want to hold a lot of cash where can you invest? Even gold won't look good in a deflationary environment. Regarding the banks foreclosing, under what circumstances would they do that? Assuming that governments will keep the banks liquid, it will be in their interests to 'sit it out' until the paper losses disappear.

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