George Kerevan: Property ripe for investors who take the long view

Published on Tuesday 9 June 2009 21:35

ARE there any green shoots in the commercial property market? Back in 2007, in this column, I wrote that the collapse in UK commercial property values was a clear signal that the bubble had burst and that a recession was on its way. That was a year before the failure of Lehman Brothers.

Picking through the entrails of the commercial property market today produces a mixed outlook for investors, with values and rents still falling internationally. But there are glimmers of hope in the UK, if only because the market collapsed early.

Analysts use a benchmark called "fair value" which measures the difference in yield between a property investment and safe gilts. The long-run average in the UK is one percentage point over the ten-year gilt yield. At the start of 2007, when commercial property values were at their insane high, the yield was negative (meaning it cost so much to buy property that the rents did not provide a return).

But as UK commercial property prices plummeted, the yield differential turned positive and is now verging on the historic "fair value", according to the analysts at DTZ. Conclusion: commercial property investment in Britain, especially if you are equity financed or a rich sovereign wealth fund, is on the cards.

DTZ predicts that the central London office market will reach fair value at some point this year even though prime rents in the City have fallen 31 per cent since their peak in 2007. Overseas markets will become attractive investments only in the second half of 2010 or beyond.

A word of caution: we are talking investment yields here. Property values are likely to go on falling for a bit. This is a situation ripe for investors with long horizons who are less concerned about calling the bottom of the market, such as pension funds and life assurers. Yet it is interesting that property companies have begun to raise capital for acquisitions. For instance, Nick Leslau's Max Property has just raised 220 million on AIM.

Are there any glimmerings in the commercial property market in Scotland? The public inquiry into the proposed development at Edinburgh's much– neglected Haymarket has centred on the 17-storey hotel, to be operated by Intercontinental. However, the 200m Haymarket project, by Tiger Developments, consists of much more than just a big hotel.

As well as a second, 245-room budget hotel, and retail outlets, there is to be 342,000sq ft of new office space. Tiger believes the capital's office market is still strong despite the financial crisis and the likely downsizing of space requirements by the banks. How credible is this?

Despite being one of Europe's major financial centres, Edinburgh city centre has long suffered from a lack of Grade A office space. Of course, the banks have built new, bespoke offices for themselves, but this has been on the city periphery. Witness the 335m RBS headquarters at Gogarburn, that monument to the days of banking profligacy. RBS may shed space at Gogarburn but that's no good for anyone needing a prime, city-centre location.

Tight planning regulations, a vocal conservation lobby and a lack of appropriate development sites meant that – even at the height of the boom – large-scale office space was at a premium in central Edinburgh.

True, there is the former General Post Office in Waterloo Place, which underwent a 100m conversion to offices five years ago. It has been empty ever since. As a result, the developer, Castlemore, went into administration in February. But this was always daft as an office scheme: far too expensive, located outside the financial zone and lacking decent access. It should have been retail space.

The upshot is that, as the commercial property development bubble burst in 2007, Edinburgh – for all the wrong reasons – was not left sitting with half-built schemes or a gigantic overhang of un-let offices. As a result, rents remained stable through most of 2008, while plummeting in other UK financial centres.

It is only now, in 2009, that Grade A office accommodation is coming on to the Edinburgh market. This includes 210,000sq ft at Scottish Widows' Exchange Place. After that, from 2010 onwards, there is not a lot of new Grade A accommodation in the pipeline, certainly not in the city-centre core.

Certainly, the recession is having a negative impact on rents, which are forecast to fall between 10 and 15 per cent this year and next. But the continuing shortage of office space in Edinburgh should ensure rents stabilise thereafter. That is why Tiger Developments are so bullish about their Haymarket office scheme.

Of course, things can still go very wrong. Rising unemployment could trigger a crisis in consumer confidence, driving the economy into a double-dip recession. The banking shake-out in Edinburgh could still hobble the local office market. But the risk-takers are returning to the property market, which bodes well.