The rate of capital growth fell by 50 basis points, to 0.8%.
Phil Tily, UK and Ireland Managing Director at IPD, told delegates at the IPD/IPF/PDIG Quarterly Q1 briefing, held in the Reed Smith Offices at 20 Broadgate Tower, that “While in the overall context of the recovery period this is a relatively sedated pace of growth, it nevertheless marks the seventh consecutive quarter of improving values. Values fell 42.2% from June 2007 to June 2009, and have since recovered 19.9%.
“Re-pricing, as measured by IPD’s yield impact, is still the main source of growth, indicating the extent to which returns are principally determined by underlying investor sentiment. It does appear that the recovery period, which began two years ago, was a front loaded affair, with returns having ebbed away in the past nine months. Values are still rising and yields are still falling but at much reduced rates.”
Rental value results remained positive for the third consecutive quarter, up 20 basis points in the last three months, and are now playing their part in the overall performance numbers.
While the overall income return continues to trend down, it is worth observing that with the drop off in capital growth returns in property have now become more income based.
Sector returns
For the seventh consecutive quarter all sectors have reported positive returns, with City Offices and Retail Warehouses standing out among the segments, having improved their performance levels.
London Offices remain at the forefront of market returns, recording 4.5% in the City and 3.2% in the West End. Commenting on the sector divide, Tily said, “Beyond London, Office performance becomes more localised – where values have gone into reverse. The further you venture from the South East, the more subdued the outlook becomes in view of the recent spending cuts, especially when you consider the levels of dependence some areas have on the public sector.”
In the Retail sector Shopping Centers, which finished 2010 with a strong Q4, saw capital growth drop off in the first quarter, down to 0.6%. By comparison, Retail Warehouses outperformed the rest of the sector with growth of 1.5% leading to returns of 3.0%
Tily continued, “It’s been reported that within the unit shop market retailers have started to trim their portfolios in order to maintain profitability levels as they struggle to compete with out of town shopping centers and online sales. This concentration of retail activity appears to be more of an issue outside the South East, where values overall are static at best. Retailers here are starting to feel the pinch, with the reduced levels of disposable income putting a squeeze on spending levels, which in turn is having a negative impact on rental values.
Prime vs. secondary
While the search for prime properties with a secure income return, which characterized the early stages of the upswing, is still evident in this quarter’s results, contrasting themes are starting to emerge.
With a lack of supply at the prime end, the Central London Office market is now seeing a rally in returns among the high yielding assets. However, other areas of the market remain more polarized: with higher yielding properties delivering the lower returns as investors remain increasingly risk adverse in the current economic climate.
Tily further observed that, “When you look at the changes in income levels, the contrasts in the market become increasingly evident: in short, prime comes out on top. Their rent rolls have held up in a period of relatively low growth. By contrast, it’s the higher yielding properties that have suffered more of the casualties, with increased instances of insolvencies, pushing rents down by as much as 20% over the last year.
“This helps us to focus on how important income protection will be in maintaining those values and driving performance levels forward – the delivery of income and its growth being one of the key qualities attracting investors to property in light of other asset classes.”
Panel discussion
The subsequent panel discussion, chaired by Phil Clark, Head of Property, Aegon Asset Management, included Phil Tily, Anthony Shayle, Head of UK Business/Managing Director, UBS Global Asset Management, Claire Higgins, Head of Research, BNP Paribas Real estate, Paul Ogden, Partner, InProp Capital and Kate Pederson, IPD UK Client Management, and covered a number of topics.
Shayle, when asked about investors’ attitudes to investing in prime and secondary property, said “The key issue is what investors do when they feel the growth in prime markets has peaked - once the value-added funds start moving out of the prime, strong performing sectors, looking for more risky investments. Will they go into the riskier assets in the areas that are already performing well, like City offices, or will they move into areas where they can play the rental curve game, looking to refurbish in potentially riskier locations? This is a key question in the market over the next 6-18 months.”
He went on to say about property lending, “The inactivity of the larger banks such as Lloyds, which have been very cautious about releasing property into the market, but instead are rather working through their portfolios in a logical fashion, will continue to cause an overhang. In the near future the most important activity may come from second flight banks - which don’t have ability to create substantial work-out groups - releasing their stock into the market and trying to capture some of the upturn which is coming through.”
Claire Higgins, when asked about the effects of quantitative easing, said: “The gap between the property and gilts yield is definitely starting to narrow, and property people are not always aware, as they should be, of the effect of what is happening in other asset classes on the sector. We are not likely to see any more quantitative easing, and this a cause for concern for property, albeit just one among a large number of concerns.”
Shayle commented further on gilt yields and the implications for bank lending to property: “The movement in gilts yields should partly be seen in terms of demand; are gilt yields rising because money is flowing away from gilts to other asset classes such as property? But gilt yields also tend to track swap rates, and at present the relationship between swap rates and bank lending is an odd one: the amount of bank debt being created is extremely low, which is probably the most significant factor behind volumes in the real estate market: the prospects for investment flows into the property market therefore remain bleak.
“The flow of funds into the market that one would expect to see at this stage of the cycle isn’t materializing, and gilt yields are creating a lot of confusion in the overall story.”
Higgins added, “The bank lending question isn’t just a short term one. With Basel III on the horizon, increasing the requirement for capital cover, limited bank lending is likely to continue as a potential negative factor for some time to come.”
Source: IPD
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