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RICS and IPD Index predict a property slump worse than 1970s and 1990s

17 December 2008

Over the next two years commercial property capital values could fall by a further 25 percent according to the RICS forecast, while IPD Index also shows record falls in returns and capital values.

RICS expects the commercial property market to see at least 16% declines in capital values in 2009 and a further drop of up to 10 percent in 2010. Since the onset of the credit crunch in June 2007, capital values have already fallen 25 percent and with more falls to come, the cumulative downturn in prices will exceed the downturns experienced in both the 1970’s and 1990’s. Rising defaults and credit spreads will constrain a near term recovery in financing, preventing any recovery in the investment market over the next couple of years. Low interest rates, recovering global growth and improving valuations relative to other asset classes should see the downturn gradually begin to reverse on 2011.

The biggest declines are likely in the office sector with capital values expected to drop a further 30 – 35 percent bringing peak to trough declines in excess of 60%. Employment in banking, finance and insurance has accounted for the lion’s share of job creation since the millennium although has moved into decline over the past year. An acceleration in this trend is set to weigh on demand for office space, undermining rents. The retail market is also likely to suffer a similar fate and see capital values drop by a further 25 - 30 percent as consumers tighten their belts. The retail warehouse market is feeling the impact of the downturn and a further slowing of big ticket purchases is expected as transactions in the housing market remain subdued. Capital values declines in the industrial sector are expected to be less pronounced, falling a further 15-20% percent over the next three years, helped somewhat by a weakening pound and slow recovery in the global economy towards 2011.

Price declines will be exaggerated by falling rents and an increase in distressed selling as refinancing pressures bite. RICS expects rents to fall by ten percent in 2009, four percent in 2010 and three percent in 2011. The office sector is expected to be hit hardest with a 16 percent decline in rents in 2009, 11 percent in 2010 and six percent in 2011. With consumer confidence at its worst level for over a decade and consumer spending already falling, retail rents will also suffer. RICS expects rents in the retail sector to fall by seven percent in 2009, six percent in 2010 before stabilising by 2011. Rents in the industrial sector will be marginally flatter than elsewhere but even so rents are expected to fall by six percent in 2009, five percent in 2010 before beginning to edge upward by 2011.

Commenting, RICS senior economist Oliver Gilmartin said:
“We are only half way through the price correction in the commercial property market with values set to fall through 2009 and 2010 as rental declines gather pace. Transaction activity is set to rise, however as more sellers become willing to accept lower bid prices. On a positive note, the rapid re-pricing across the market has pushed UK yields to among the highest in the developed world with a very wide gap emerging compared to finance costs. For unleveraged investors (like pension funds), high yields provide good long term value especially for prime properties. Stimulus plans by central banks worldwide and accelerated fiscal packages, might see a return to higher inflation once the worst of the current slowdown has passed, with property tending to act as a good hedge.”

IPD Index:
UK commercial property returns for 2008 look set to surpass the landmark losses recorded in 1990, on a real returns basis, with All Property total returns now at -18.2% over the 11 months to November 2008,
compared to an inflation-adjusted return of -16.2% almost 18 years ago on the UK Annual Index. The largest ever annual total returns loss for UK commercial property, on a real return basis, was -29.4% recorded back in 1974.

For the second month in a row total returns and capital values for UK commercial property have broken records for the largest monthly falls with returns of -5.1% and - 5.7% respectively, according to the November IPD UK Monthly Index. Over the year-to- date All Property capital values have fallen by -22.6%, and over the last 16 months by -31.5%. This compares to capital value falls of -27.0% between November 1989 and May 1992.

The combined drivers of capital movement – yield impact and rental value growth – remained in negative territory over November, explaining the observed dramatic falls in capital values. Yield impact, the effect of the movement of yields on capital values, was -5.3% month-on-month for all UK property whilst the market witnessed a weakening of rental values at -0.5% month-on-month. A modicum of good news comes from sustained income levels, with the All Property income returns providing 55 basis points, despite a slight increase in voids.

At the sector level, Offices overtook Retail as the steepest faller, with capital value falls of -5.8% and -5.7%, respectively. Since April, rents have fallen faster in Offices than Industrial or Retail, at a rate not seen since July 1993, at -1.4%. Overall the total returns for Offices, Retail and the Industrial sector were -5.3%, -5.2% and -4.8%, respectively.

Ian Cullen, IPD co-founding Director, said: “With an 11-month nominal return to November of -18.2%, we are precariously close to the worst 12-month real return on record – to date that of 1974 at -29.4%.”

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