UK commercial property -
no recovery until 2009

Each quarter Reita publishes an Expert Panel Survey and follow-up thought piece to give an authoritative property industry view on key issues and current market sentiment.

read the Reita Expert Panel survey results

Further to the expert panel research, Patrick Sumner, chairman of Reita (and head of property equities at Henderson Global Investors) led the Reita market review panel discussion, which examined some of the experts’ findings in more detail:

Update – since last quarterly perspective

UK property stocks have fallen back to their lowest point this year. This is despite the rally in property share prices earlier this year, when it seemed that the end of the commercial property correction might be in sight - and shares rose by 16% in three weeks.

Property share prices have been a fair indicator of direct market trends, and January's optimism has all but disappeared. Analysts are uniformly bearish, not merely about where values are headed, but also about how long it will take to get there – which is much longer than previously thought. This is despite the rate of fall in capital values continuing to appear to slow. The monthly fall in values as measured by the IPD Monthly Index was only 1% in April compared to 1.3% in March, bringing the total fall to 16.2% in the last year.

What’s happening today…?

The tide may have begun to turn in capital markets, but it has left two crucial property sectors - London offices and UK retail - high and dry.

Estimates of job losses in the financial sector, vary from 20,000 to 40,000, equivalent to 5-10% of the workforce, at the same time as 6m square feet of new space is coming onstream in the next 18 months. Although much of the new space is pre-let, it is not clear how strong tenant demand will be for the un-let space .

The state of the retail market varies according to the type of goods and outlet, but even the dominant shopping centres, such as Bluewater and Lakeside, are unlikely to see much rental growth this year or next. Bulky goods retailers in secondary out-of-town locations, however, are struggling - or capitulating

The future – Reita viewpoint

Land Securities and British Land, the UK largest REITs, have both reported their full year's results in the last week. Both reported strong results relative to IPD, outperforming expectations and demonstrating the long-term benefits of owning prime quality asse ts.

However it is the immediate outlook that will be important; if the analysts are right, Net Asset Values will fall another 15-25% in the current year. Property derivative prices are also implying that UK capital values have a further 7-9% to fall, although care should always be taken in interpreting the pricing of derivatives.

Whilst much depends on the broader economy, analysts appear to be factoring in a drawnout recession in the UK. Unfortunately, even if these forecasts are wrong, property stocks have historically tended to lag other equities in a recovery, as general investors buy cyclical stocks and ignore the property sector.

More positively, there have been three announcements from Pub companies announcing intentions towards conversion to REIT status. This is undoubtedly very good news for the sector, particularly for the development of specialist REITs but care should be taken not to overreact. None of these companies has actually announced that they will convert, with only Enterprise Inns providing an outline timetable leading to autumn 2008. Conditions in both the property and hospitality markets remain difficult and since conversion depends on both significant restructuring and for M&B at least, dependent on raising finance, investors should remain cautious.

Looking further abroad…

Elsewhere in the world, the US has possibly the brightest outlook. US REIT investors tend to concentrate on cash income and dividends, which are expected to grow this year despite the weak economy. They focus less on NAVs, mainly because US REITs do not publish them, and this means that they are not distracted by capital market volatility.

Asian markets have rebounded strongly after a weak first quarter. Hong Kong property shares were up 59% in 2007, down 24% in Q1 and up 18% so far in Q2. Japan has been even stronger this quarter, up 24%. This reflects some fundamental market factors, but for the most part it is based on a more confident view of the US economy.

Europe has outperformed the UK, up 5% while the UK is down 9% in Euro terms. Sterling weakness explains around 5% of this difference.