Is real estate perking up?
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Associate Editor
David Stevenson Oct 30, 2009
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Commercial property looks to be back on the up, but with the public in frugal mood, can it really be time to buy back in? David Stevenson reports.
Between mid-2007 and July this year, UK commercial property prices almost halved. But recently there have been signs that the sector is bottoming out, and real-estate stocks have soared in the past six months. So is it time to sound the all-clear?
The latest commercial property survey from the Royal Institution of Chartered Surveyors (RICS) was certainly upbeat. It showed that both enquiries and new letting activity rose for the first time in two years during 2009's third quarter. Perhaps predictably, London is "leading the turnaround in tenant activity, with retail and office demand moving into expansionary territory at a faster pace than elsewhere", reports RICS. "Central and greater London office markets saw tenant demand rise for the second consecutive quarter and at more than double the pace of the previous survey period."
The office market is the most optimistic, while industrial property "is also gaining some support from the improved economic backdrop", says Oliver Gilmartin at RICS. "The laggard remains the retail sector." But even here, Land Securities, Britain's biggest property developer, is talking tougher. Amid rising demand, the group is reluctant to offer cut-price rental deals to cash-strapped retailers to try to fill vacant stores. "We do not believe across-the-board changes to agreed contracts are appropriate," as CEO Francis Salway put it.
Maybe he's right – for now. The trouble is, prospects for the UK commercial property sector are intertwined with the spending habits of Britain's consumers. And right now, big spending is not on most consumers' agendas. Despite upbeat surveys from industry groups such as the British Retail Consortium, September's official retail sales figures were far weaker than expected. Overall monthly sales were flat, with non-food sales falling over the previous two months. It's little wonder. For one thing, consumer credit growth has slowed to a crawl. In August it rose by just 0.7% year-on-year, the slowest recorded expansion since the Bank of England started keeping track in 1994. And although mortgage interest costs for millions of homeowners have shrunk to almost nothing on the back of Britain's lowest-ever bank base rate (0.5%), many are cutting debts rather than raising spending.
In the second quarter of this year, homeowners repaid a net £7bn to their mortgages, a complete reversal of the 'home as cashpoint' mentality seen just two years ago. People are also putting more of their disposable income aside for a rainy day. The UK's savings ratio has steadily risen to 5.6%, from zero 18 months ago. This is cash that won't be spent in the shops.
What's prompted this flight to frugality? In short, people aren't stupid. They see the dole queues getting longer, and fear there's worse to come. Further, they realise the government has to cut spending. That will mean big cuts in public-sector jobs, and higher taxes too. In short, the long-term outlook for retailers, and the landlords who own their shops, is anything but bright. And given that consumption accounts for more than two-thirds of the British economy, it'll have an impact across the rest of the commercial property sector too.
A short-term bounce
For now, short-term factors are masking the longer-term dangers. The recent plunge in the pound has slashed the cost of residential and commercial UK property for overseas buyers armed with strong currencies such as the euro. It has also cut the cost of Britain's exports to overseas buyers.
Last week's industrial trends survey from the Confederation of British Industry (CBI) showed UK manufacturers were more upbeat on export prospects for the year ahead than at any point since July 1995. That suggests they'll need more manufacturing capacity, which would help property valuations. Yet it would be a mistake to get too excited. The rest of the world has plenty of problems too, so sterling may not stay as weak as it has of late. When current global government stimulus programmes, which have artificially boosted economic growth numbers, expire, it's not clear what's going to fill the void. Any recovery will be protracted and weak, with constrained investment and rising unemployment, says Ian McCafferty at the CBI, while the "tight flow of credit" remains worrying. With global demand for goods weak, exporting our way out of recession will be tough – hardly good news for demand for industrial property.
What about offices? Again, the most recent CBI/PricewaterhouseCoopers survey suggests that financial services companies are increasingly upbeat about business prospects. "At face value, the continued optimism in this survey points to all-office rental values recovering over the next 12-25 months," says Kelvin Davidson of Capital Economics. But he's not convinced. Even the CBI/PwC survey admits that "cost control remains a priority" and that "head count is falling across most areas of financial services". That means less demand for space. With this in mind, Davidson reckons "office rental values still have considerably further to fall, perhaps by an average of 10% across the sector".
Historically, property price pick-ups have coincided with recoveries in lending. And property bulls will point to recent Savills research that found a sharp rise in the number of lenders willing to make loans against UK commercial property.
But banks "are still highly exposed to commercial property and tenant defaults remain a concern", warns Davidson. "We're sceptical that lending volumes are suddenly set to rebound sharply. Any mini-boom founded simply on sentiment and liquidity raises the scope for an overshoot, and renewed capital value falls in 2011 and 2012." In other words, if prices rebound rapidly just now, they'll just fall further later on.
All of this might not matter if British commercial property stocks were pricing these dangers in. But they're not. In fact, they have outperformed the wider market hugely since the March rebound. The real-estate sector has rebounded by nearly 80% since 9 March, compared to a bounce of around 46% for the FTSE 350. If you hold stocks in the sector, we'd that suggest now is a good time to take profits.
So where does look a better bet for commercial property. Eoin Gleeson and Jody Clarke have a couple of tips:
• Jody Clarke looks at some solid bets in Asia: Promising plays on Asian real estate
• Eoin Gleeson looks at how one property sector is profiting from the US's ageing population: American medical property bucks the downturn
• This article was originally published in MoneyWeek magazine issue number 459 on 30 October 2009, 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
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