The media are bombarding us with bad news stories about the residential property market.
For example, it was reported the Nationwide Building Society’s latest survey showed house prices recorded their largest monthly fall since 1991.
Prices dropped 2.5 per cent in May and are apparently now 4.4 per cent lower than a year ago, a fall of £8,000 on the average UK price, taking the figure down to £173,583. But what of commercial property? To recap, we all know this market had a particularly testing 2007 with sharp falls in capital values. before 2007, UK commercial property had delivered positive returns every year since 1993 and returns of 15-18 per cent were not rare three or four years ago.
A combination of rising interest rates and the credit crunch lie at the heart of last year’s falls in UK commercial property values. Although the UK commercial property market was already slowing, its impact was effectively to put a freeze on property transactions.
As a result, property was valued primarily on negative sentiment rather than transactional data. As the value of commercial properties was marked down, so was the value of funds that held them.
What has happened in 2008? As recorded by the Investment Property Databank (IPD) Monthly Index, the UK commercial property market generated minus 3.4 per cent in the first quarter outperforming the FTSE All-Share Index (minus 9.9 per cent).
Despite the fact capital values have fallen 14 per cent over six months, rental growth remained healthy at two per cent (last three months annualised, IPD Monthly Index) and quarterly income returns have increased (from 1.2 per cent the third quarter of 2007 to 1.4 in the opening quarter of 2008 according to the IPD Monthly Index).
More promising figures have been published by the Investment Management Association (IMA), which show retail investors are continuing to return to commercial property funds with inflows of £71 million in April.
According to the latest IMA investment fund statistics, this level of investment followed inflows into the property fund section in March turning around the four previous months of outflows from property funds.
Richard Saunders, the IMA’s chief executive, has said: “After two extremely modest quarters, net retail sales bounced back in April to £1.5 billion, the best for a year.”
This good news, as is becoming increasingly familiar in the current environment, is tempered with bad news. Increased borrowing costs and pronounced nervousness in the financial services sector has reduced property investment market liquidity, decreasing transaction volumes and generated downward pressure on property valuations.
The lack of syndicated bank lending has reduced the liquidity of larger lot size properties, – those greater than £20 million. More bad news was demonstrated by the £2.9 billion Mall shopping centre fund, managed by a subsidiary of Aviva, believed to be less than one per cent away from breaching a 60 per cent loan-to-value covenant on debt.
The fund has been forced to announce a £300 million deeply discounted rights issue to restore balance sheet ratios. But this doesn’t guarantee shares in The Mall, already more than 80 per cent down on last year’s high, won’t go lower.
While 2008 will be a difficult year for commercial property in the UK – as with many other asset classes – let us see what we can learn from history. History shows falls in UK commercial property do happen.
The last time commercial property values fell as substantially as they did in 2007 was in the early 1990s. Nevertheless, over 20 years, a time span that covers both these periods, UK commercial property has risen in value 82 per cent.
If you include rental income, the total return from UK commercial property has been 628 per cent. By way of comparison the total returns from equities and gilts over the same period were 685 per cent and 422 per cent respectively.
