Commercial Property Market
The stock market doesn’t believe property prices will recover
As you may already know, we’ve not been keen on commercial property in this country for a long time.
There was huge price bubble in 2005 and 2006, just before the UK’s property companies turned themselves into REITs (real estate investment trusts). That was supposed to be great for investors because of the tax benefits. REITs avoid capital gains and income tax if they pay out most of their income to their shareholders.
Unfortunately, the onset of REIT status at the start of 2007 also marked the top of the commercial property market. Since then, shareholders in quoted REITs have lost almost two-thirds of their money. Despite a bounce from the March 2009 lows, investors in the sector have actually made no capital gains since 1993. Very painful.
But hang on, you might be saying. Hasn’t there been a pick up in commercial property prices recently, particularly in hotspots like the City? And if that keeps on going, won’t it work its way into REIT share values at some stage?
Well, you’d be right that there’s been an upturn in some parts of the office market. But the problem for REIT shareholders is that this has done little or nothing for the sector’s stock prices overall. That’s partly because of other problems in the commercial property market. I’ll come to them in a minute.
But the most obvious message is that the stock market doesn’t believe property prices as a whole are set for a sustained recovery. Indeed, reading between the lines of what leading player British Land had to say yesterday, another downturn in REIT share prices might not be too far away.
British Land is the biggest landlord in the City. Yet despite the upbeat chat by property market cheerleaders about a shortage of prime Central London office space – which is supposed to drive rents and values much higher – it hasn’t really happened.
Valuations of property in the City and the West End only nudged up by around 2.4% on average in the three months to 30 June on the back of a similar increase in rents. And that was the good news. Retail property values climbed by less than 1%, while rents actually dropped.
We should be worried about the looming ‘double dip’
And this is likely to be about as good as it gets. Commercial property prices are closely linked to what’s happening in the wider economy. And the outlook there is none too bright at all. British Land boss Chris Grigg – who’s not in the business of talking things down – is concerned about “a more uncertain economic outlook”.
And a ‘double dip’ will mean less demand for office space. Potentially savage state spending cutbacks will mean hundreds of thousands of public sector workers being laid off, while the government will be keen to dispose of any underused and unwanted buildings. That will hurt even the ‘strong’ areas of Central London.
As for retail property prospects, just look at what Simon Wolfson, CEO of fashion chain Next, said this week. He’s seen “a noticeable cooling in retail demand in recent months”. And he reckons “second-half consumer spending will be more restrained as spending cuts and tax rises take effect”.
This could well signal the end of the line for already cash-strapped storekeepers. In turn, that could mean more empty sites, rents falling further and lower valuations.
Yet… might there be one last hope for commercial property? After all interest rates are ultra-low right now – the Bank of England kept the bank rate at its record low of 0.5% yesterday. So won’t investors be looking for the rather better yields that bricks and mortar offer?
Steer clear – commercial property prices are expected to fall
Not according to Capital Economics’ Kelvin Davidson. He points out that nearly two-thirds of the respondents to the REITA property survey expect to see rising yields over the next 12-24 months. In other words, they expect prices to fall. And so they’ll be happy to sit on their hands (and their money) until they see more bargains hit the market.
And as for people buying commercial property on borrowed money, take a look at this scary chart from Capital Economics.
Net lending to property has actually turned negative – i.e. as a group, borrowers are repaying their loans to the banks, rather than taking out increasing sums of money. This could be the case for a while – the last time it happened, in 1991, it took five years for the net commercial property lending to start expanding again.
What does this mean for investors? It looks pretty clear to us. Don’t be tempted by the massive plunge in the sector’s share prices over the last three and half years – there’s plenty more bad news on the way for commercial property stocks. If you want income, the defensive high-yield shares we keep tipping look a much better bet: