Market Prospects

• Last year’s consensus view, that the property market was heading for a soft landing with rental growth supporting values as yields began to stabilise, has proved wide of the mark. Some analysts are not predicting a return to positive returns until 2010. Capital values are still falling month on month, although the rate of decline has begun to moderate. However, as mentioned above, this may change if the occupier outlook worsens and rental values start to decline.

• The IPD forward curve is now implying capital value movements of -17.25% in 2008, -2.83% in 2009 and then +0.8% in 2010. In 2011 and 2012 implied growth is still fairly marginal at +1.9% pa.

• 90% of investors think the fall in capital values will have ended by early 2009, but only 70% of bankers share this sentiment. The fact that the UK market has fallen further and faster than other European markets has lead some investors to believe that the pain will be over more quickly, and that fair value will be reached sooner rather than later. Apart from notable exceptions (eg City of London offices) property markets will have limited quality space to meet increased tenant demand as a result of the fall in speculative development now being seen. This implies that the fundamentals for future rental growth will be in place at the end of the current downswing, provided that occupational demand holds up. The question for investors is therefore how strong do they perceive the risk of recession and financial market meltdown to be? Prime property now appears well placed for long term players to start considering buying opportunities. Investors waiting for clear evidence that yields have peaked may find themselves struggling to make purchases once a recovery gets underway.

Retail

• The liquidity crisis, housing market weakness and the fragile state of consumer spending continue to dominate the headlines. Overall tenant demand remains reasonably good, although there have been a few profit warnings recently from retailers such as DSG. Those sectors which deal mainly in ‘big ticket’ items, such as furniture and expensive electronics appear to be faring worst from consumers’ unwillingness to spend. On a more positive note, a number of retailers remain active and are still looking to expand in 2008. Major shopping centre schemes that are in the pipeline are also still receiving strong levels of retailer interest.

• High street rental growth appears to be continuing, albeit at a fairly moderate pace. The annual rate of growth is around 2.5%, with the South East, West Midlands, South West and Scotland continuing to outperform the average.

• Yields on shopping centres continue to drift outwards with prime yields now reaching 5% and secondary yields falling well into the 6% range.

• Retail warehouse performance is no longer seen as being pre-eminent, with the sector’s performance falling well below that of high streets and shopping centres. Total returns amounted to -10.4% in 2007, and annual rental growth slowed to 0.16% pa, the lowest in 20 years. Redemptions in Unit Funds have lead to several retail warehouse parks being placed on the market, leading to an excess of investor supply over demand and further weakening yields.  The strongest demand is for smaller units of between 5,000 to 10,000 sq ft with Open A1 Planning Consents on established retail parks.

Offices

• For the first three months of 2008 occupier demand for offices remained reasonably good following on from  the last quarter of 2007 when there were office lettings of over 100,000 sq ft which established new rental levels in Bristol, Reading and Uxbridge. However, a trend began to emerge during March and April of demand slackening quite rapidly. In Q1 2008 35% more Chartered Surveyors reported a fall in demand for offices compared to 13% in Q4 2007. Available space rose in the office sector for the first time in four and a half years.

• In London, the West End market has held up comparatively well given the shortage of Grade A space, with the vacancy level remaining low at 3.1%, down from 5% at the beginning of 2007. Prime headline rents stand at £130 per sq. ft..  In the City of London, the outlook is much gloomier, with a sense of nervousness surrounding possible and confirmed redundancies, and how this will impact on tenant demand. Some major requirements have been put on hold or dropped, and a number of development projects are also on hold due to funding issues and fears about rising construction costs. There is, however, close to 7m sq. ft. of new office accommodation in the course of construction of which just under 6m sq. ft. is available to let. This huge over-supply when combined with reduced levels of demand will inevitably put pressure on rents to fall .Yields have moved out by about 1% when compared with a year earlier.

• In the Thames Valley occupier demand is holding up fairly well, but investor sentiment is much more cautious. Well let buildings on long leases at attractive yields will sell, with prime yields now at around 6% but remaining under further upward pressure.

• Regional markets have generally held up as far as rental levels are concerned, but all are facing upward pressure on yields. Rental growth is expected to be slow or non-existent for the rest of 2008.

Industrial

• Despite the wider economic uncertainty, the occupational market is stronger than it has been for some time, with good tenant demand across all size brackets. This has not, however, translated into rental growth given the amount of available space. Industrial rents only grew by 1% in 2007, well below the level of inflation.

• Prime industrial yields have moved out by about 0.5% over the last quarter, with most prime units now yielding around 6.5% and secondary well into the 7% range. There are instances of investments being first marketed towards the end of summer 2007 at yields of 5.75% now being sold at yields of around 7% - implying a fall in capital values of 22%. Evidence suggests that the fall in capital values may have been most acute in the large distribution and logistics sector.

• A degree of price softening was noticed in the final quarter of 2007 as investors woke up to the implications of the abolition of empty rates relief. Whilst sceptics may see the measure as a revenue raising exercise, the Government hopes that it will bring forward derelict property on to the market. It is expected that this measure will primarily have a detrimental impact on speculative investment in regeneration areas – quite the opposite of what the Government hoped for, as developers will be deterred from investing in rundown areas where occupational demand is weak and there is a greater chance of properties remaining vacant over prolonged periods.

Sources:  Cushman & Wakefield, Fletcher King, RICS, IPD, Strutt & Parker, CBRE