What is going on in the commercial property sector?

So what are the key drivers? Is this a great buying opportunity or the last opportunity to get your cash out? The answer is very much dependant upon whether your focus is on prime or more secondary property.

Prices for prime property have been rising across all sectors since Easter 2009. Purchasers have continued to be attracted by the relatively high yields compared to other asset classes and inevitably rising prices have reduced the income returns. Typically within the prime sector yields are now in a range between 4% and 8%. Demand is relatively stable from the institutional investors and we expect prices to continue to slowly trend upwards over the next 6 to 12 months. There is virtually no speculative development being undertaken so the supply side is relatively finite.

But what of the future for secondary stock? During the last two years, many property investors breached their loan to value covenants, resulting in the banks now controlling significant property portfolios. Historically, this might have produced fire sales, driving the market down further. But the banks had taken heed of the past and only now, as prices stabilise, are they beginning to look for ways to exit; or reduce exposure to these properties.

Secondary yields are in a wide range of between approximately 7.5% and 14%, depending on the perceived level of risk This sell off being instigated by the banking sector, coupled with concerns over re-letting prospects, will result in a significant rise in supply. There are no indicators suggesting a rise in demand for secondary property. Primarily for this reason we suspect prices will drift down over the next 12 months. Moving yields out even further.

In considering commercial property assets, we can’t ignore wider economic factors that are creating a highly deflationary environment. Yet the spectre of uncontrolled inflation is hovering just over the horizon. Experts are divided on this issue. In our view there is a pervasive logic to governments reducing the level of their monstrous debts by inflating them away, whilst also protecting equity markets and commodities. Traditionally property has been viewed as an inflation hedge.

A further concern is the precarious position of sterling and the Euro, with overseas investors becoming attracted as they fall, but being unlikely to invest until they believe the currency has reached a floor.

So is there any good news? Yes definitely. In my role as a real estate advisor I meet many people and the vast majority are telling me their business is improving. As company’s earnings continue to stabilise and rise, this will gradually result in the return of occupier demand. We have seen significant new lettings and rising rents in the City of London and there are other rising location-specific demands. It is the rental streams from the occupiers that underpins the commercial investment market. In our view they have generally reached a floor and the next direction is likely to be up.

Worldwide economic events and supply demand mismatches will continue to cause undulations. But all other things being equal we expect prime property prices to rise and more secondary property to start to follow this trend in 18 months time. The upward curve will steepen as confidence and the availability of finance return to the market.