Economic and property market overview
All property total returns were 2.0% in the April-June 2011 period, according to the IPD Quarterly Index versus 2.3% in the previous quarter and are 9.8% compared with a year ago.
The past year has seen total returns move in a narrow range, largely driven by income supplemented by modest capital growth. The slightly weaker quarterly performance was due to a deceleration in the pace of capital growth to 0.5% during the quarter from 0.8% registered in the previous three months.
Capital values have risen by more than 20% from the market trough of 2009 but are still down 30% from the market peak. Economic activity remains subdued and there is a growing recognition that the austerity measures are not a short-term policy initiative but will have a depressant effect on domestic growth for several years.
Economic data for the second quarter has been distorted by bank holidays but there are signs that momentum has slowed and both business and consumer confidence has slipped while a rash of retail failures has caused concern. Inflation has moved up and this has exacerbated the squeeze on consumers’ real disposable income.
There is also concern about growth prospects of other nations as much of the improvement seen to date has been export driven, while debt problems in the periphery have intensified, heightening fears about contagion and the strength of the banking system to withstand further shocks.
The UK monetary authorities remain torn between the need to combat inflation and support growth but the last quarter saw no change in interest rates or the quantitative easing programme.
The government remains committed to its fiscal programme but the deficit remains stubbornly high and the Office for Budget Responsibility has indicated that further measures may be needed to achieve longterm stability.
There is economic growth but recovery is hesitant and patchy. The property market has seen two years of growth. The first year of the recovery was driven by yield compression, especially at the prime end as risk averse investors competed for a limited amount of such stock.
Initial yields moved in by 140bps in that first year but this has moderated to 30bps during the second year of recovery.
Yields moved lower in the 2Q 2011 but by only 10bps. Property still remains fairly priced against gilts given the historic risk premium, helped by a fall in gilt yields as investors increasingly favoured safe havens.
Investment activity fell back in 2Q 2011 to £6.6bn from more than £10bn in each of the previous two quarters. Central London offices bucked the trend with a slight increase in market activity but elsewhere there were very sharp declines. In part this reflects a lack of stock but also a mismatch between investor demand and supply.
Investors are still wary of secondary stock and there remains a disparity in price expectations between buyers and sellers. Prime stock remains in short supply and subject to competitive bidding, especially in Central London. Institutions remain net buyers of property but at modest levels with overseas investors and private property companies being the main market drivers in 2Q 2011.
The banks are continuing to work through their problem loans and almost £1bn of stock was sold by banks/finance houses in 2Q 2011 while other sales will have been from distressed vendors at their behest. The banks are also selling off debt rather than assets.
The problem though remains enormous with the Bank of England estimating that a third of the £200bn plus of UK commercial property loans could be subject to some form of “forbearance”, with a fifth of loans due for repayment in 2011 and banks still reining in their lending.
Although quarterly total returns have been relatively stable at the all property level for a year, there are differences within the market. Offices have out-performed the other two main sectors, driven by Central London. Retail performance slipped during the quarter delivering a 1.8% total return, in line with industrials.
The main differences in performance continue to be geographic and qualitative with London out-performing the provinces and prime generally out-performing secondary. The occupier market has remained subdued. Rental values rose by 0.3% in the quarter, with falls in the retail and industrial markets being offset by higher rents for office property in Central London.
There is concern that the occupier market could weaken as the austerity measures take effect and deals are taking time to complete reflecting uncertainty among occupiers. Void levels remain close to 10% and income streams are under pressure, especially for industrial and secondary stock.
Property delivered an income return of 6.2% in the year to June 2011 which is attractive when compared with equities, gilts, cash and inflation.
Investor sentiment remains cautious and property is benefiting from this as the flight to safety has raised the yield gap against gilts and reduced the swap rate. Property is perceived by some as a hedge against inflation and its high and steady income return is also attractive to investors.
Property performance has been resilient in the face of economic uncertainty. The economic outlook poses challenges but property is forecast to deliver positive total returns, driven by income.
The economic and property market outlook
There are growing concerns that the second quarter soft patch of economic data seen in the US and Europe may herald a more lengthy period of slower growth and that the debt problems of the periphery may be more severe and intractable than earlier believed, possibly leading to contagion to the “soft core” larger economies of Italy and Spain.
The consensus GDP growth fo
