UK property market update

Confidence returns to UK commercial property...

Since the summer, we have been talking to you about the triggers that we believed would indicate an imminent recovery in the UK property market. This was at a time when conditions for commercial property were continuing to deteriorate but at what we perceived to be a slower pace. As we predicted, there has been a noticeable revival in the UK commercial property market over the past few months and a subsequent improvement in the performance of property..

Capital values, as measured by IPD, rose for a third consecutive month in October. In addition, flows into UK property funds recorded the largest quarterly increase in two years, according to the Association of Real Estate Funds. Overseas buyers have led much of this renewed interest in UK commercial property, enticed by favourable exchange rates and relatively attractive pricing, but the level of interest among UK investors has also risen sharply.

... but limited stock is a challenge

However, while interest in the asset class is undoubtedly growing and property funds now have money to spend, buyers currently face a scarcity of prime quality stock. Unlike the property cycle of the '90s, speculative development has been better controlled during this cycle. This time round, property developers reduced the supply pipeline when development funding largely dried up and economic conditions worsened. And they have kept it that way for the last 12 months.

Meanwhile, UK banks and financial institutions have added to the logjam by holding on to distressed assets that were seized at the height of the financial crisis. It was widely expected that the banks would flood the market with these properties, however, this hasn't happened. The banks have instead held onto these assets, rather than sell at low prices, meaning a lack of acquisition opportunities for cash-rich investors and property funds. This situation has given rise to some competitive bidding situations for available properties, particularly in the London offices sector, which is pushing yields lower and prices higher.

So where to next year?

Unsurprisingly, some commentators are concerned about the prospect of a pricing bubble and that the UK commercial property could suffer a temporary setback - especially if prices continue to rise without an accompanying up-tick in economic or rental growth. Until a state of equilibrium returns to the supply/demand of UK commercial property, the current situation will likely be self-perpetuating.

However, our belief is that the UK banks will encourage over-extended, leveraged property clients to offer stock to the market as pricing continues to improve, rather than flood it with a large volume of assets. And we still believe UK commercial property is an attractive investment opportunity, particularly given the yield advantage it offers over other asset classes.