Despite alarming headlines over the last 18 months, the residential property market has fallen by only 17% since its peak in January 2008 to February 2009, according to the Land Registry. Economists suggest the important relationship between income and property prices (we cannot spend more on housing than we earn) is still miles out of line and talk of recovery is clearly premature.
However, according to Investment Property Databank (IPD), commercial property values, of more relevance to investors, have declined from a mid-2007 peak by 41.2%, including 3.1% in March 2009 alone. Logic would dictate that, because the commercial market has fallen so much harder and faster than its residential counterpart, it is almost certainly nearer to hitting its bottom.
Most commercial property analysts are confident that developers have avoided the most extreme excesses of the early nineties, supply is not as bad as the late eighties and early nineties, the construction industry is less speculative and the surviving developers are more stable.
Added to this, the positive flipside of prices falling (where there are constant contracted rents) is that rental yields are steadily increasing. E.g. a million pound property with £4k monthly rent yields 4.8%, but if the rent stays the same and the property is now worth £600k, the yield is now 8%.
The current 8% yield is obviously attractive in such a low interest rate environment. In addition this may also signify an important structural change in the commercial property market as, between 2002 and 2005 over 60% of returns were from capital growth, but somewhere close to zero growth can be assumed for the next few years. Therefore it is likely to be rental yield that will drive any growth in the sector, in the near future at least.
Before getting too carried away with the positive yield story though, it is questionable whether rents, even supported by upward-only rent reviews, can be maintained given the depth of recession. This is likely to apply especially in the City, where there is so much extra capacity poised to become available in developments which were started during the boom years, 2 or 3 years ago, and will be becoming available in the next 12 months.
JPMorgan estimates that London rents will fall almost 50% peak-to-trough and City vacancy rates will rise to 16% by the end of the year. As prices are unlikely to rise over the next year, seeking quality tenants on long leases will be vital until the time is right to adopt a more aggressive policy.
Commercial property has a way to go before again looking attractive in its traditional role, as a diversifier, in a well balanced investment portfolio.
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