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UK commercial property sector at a standstill

UK commercial property sector at a standstill

This week the government agreed to underwrite hundreds of millions of pounds in mortgages on new build homes to resuscitate the UK housing market.

But the latest data compiled by Investment Property Databank (IPD) shows that the UK commercial property sector could also be in need of a lifeline.

According to the IPD UK monthly index, capital growth in the UK commercial sector has ground to a standstill. Total returns for October stood at just 0.6% and were almost entirely income driven, the data shows.

Perhaps most worrying is the slowdown in central London office space, which saw capital growth slow to 0.4% and rental values cooling for the first time in over six months.

Phil Tily, IPD UK and Ireland managing director, said: ‘Central London retail and office values have been driving returns since the recovery began. However, in the last few months there have been increasing concerns over a pricing bubble in the capital, which the European economy could further exacerbate.'

Investors have been faced with a barrage of negative indicators over the past three months. One of the main concerns for the UK outlook is that the full impact of public sector cuts has yet to be felt.

Flat index

The European debt crisis is another main driver of sentiment, according to Greg Mansell, research manager at IPD, who said that one of the most telling measures is the European Sentiment Indicator (ESI).

The index, which is produced by the European commission and covers representatives of the manufacturing, services, retail trade and construction sectors, as well as consumers, remained broadly flat in October.

Earlier in the year, many investors were hoping that increasing demand in the secondary commercial market, anything other than prime London assets, would drive sentiment up as the UK headed out of recession.

‘In Q2, we noticed a lot of people starting to invest in the secondary commercial office market for added value, but then in Q3 we saw that confidence diminish. Now there only seems to be appetite for the prime London locations,’ said Mansell.

One of the problems faced by property developers is getting affordable financing from banks looking to reduce their exposure to property.

A research paper by the Investment Property Forum (IPF) into development finance in the UK found that while debt is available for many developers, it has become much more expensive and developers are finding it economically unattractive in many instances.

According to the IPF report, many developers are resigned to the view that it is a new world and in order to survive, they must adapt their business models.

One reaction to this could include more institutional and mezzanine property funds turning to development lending as a way of achieving their target returns.

Focusing on the poor end

Robert Boag, who manages Ignis Asset Management’s UK Commercial Property investment trust, said: ‘Banks today want to invest in the quality end of the market and in portfolios like ours with exposure to prime central London.

‘But it’s becoming increasingly expensive because of the regulatory burden. So they are focusing on reducing their exposure to property at the poor end of the market.

‘That’s why you’re starting to see certain life companies getting involved and funding property companies. We did consider that possibility when we launched the fund in 2006 but we have a relationship with Barclays who have provided us a drawdown facility,’ he said.

For developers without that relationship, the future could see more institutional and specialised debt funds launching to fill this gap in demand for lenders.

But as Elma Morris of EMJS Consulting warns: ‘More research is needed to understand the opportunities in this market. Development finance does not fit well with the returns demanded by [the institutional] investor base. It also requires a very different skill set and uses up far more resources than direct investment acquisition.’

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