Bill Jamieson: Why Scotland needs to get building

There is a danger that Edinburgh is retreating into a psychology of isolation. Picture: Kate Chandler
There is a danger that Edinburgh is retreating into a psychology of isolation. Picture: Kate Chandler
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OF ALL the sectors in Scotland that took a battering in the aftermath of the financial crisis and recession, construction and property were the most severely impacted – commercial property in particular.

Five years on, the decline in commercial property continues, with little prospect of an immediate recovery. Construction activity remains 18 per cent below its last cyclical peak. Private sector construction activity is down some 30 per cent on pre-crisis levels, and commercial property values down between 35 and 40 per cent on five years ago.

The Registers of Scotland has released figures showing the value of commercial property sales in Scotland has plunged from more than £6 billion in 2006-7 to barely £1bn in 2012-13.

So the sixth annual conference of the Scottish Property Federation on Tuesday has much to occupy it. Such a climate would suggest a hope-shattered, funereal affair… a despairing wander round the graveyard of past glories as grieving developers swap tales of misery and loss.

A myth has grown around the period before the crash – that there was a frenetic and unsustainable surge in development activity comparable to that seen in Spain and Ireland. But there was no such comparable surge here. The sector is mired in what Bank of England Monetary Policy Committee member Ben Broadbent described as “a boomless bust” – the legacy, not of a construction boom, but a bank lending boom.

Why should a slump in commercial property matter? There is a real danger that Edinburgh in particular, with its obsessive concern with heritage, is retreating into a psychology of isolation, and will become an introspective museum-piece.

In the house-building sector, dramatic improvements have been made in building standards, energy efficiency and sustainable living. But a broad-based uplift in building quality and efficiency here awaits a greater supply of mortgage finance.

Office and working conditions are also subject to continuous adaptation and improvement to keep pace with changes in information technology and communication. And the property portfolio of the Scottish Government will also find itself increasingly in need of refreshment and renewal. The country cannot be run from unsuitable, out-of-date or poorly sited buildings for much longer.

So a commercial property recovery matters greatly. That is contingent on a more general upturn in the economy. But as David Melhuish, director of the Scottish Property Federation, summarises, the commercial property sector is a key component of the wider economy “and if there is a lack of activity then this means businesses are not on the move, growing and entering into new ventures”.

Commercial property, he adds, is an important factor of investment for pension and life funds – including many public sector pension funds. “Therefore if rents are depressed by policies such as hugely increased empty property rates charges then the investors lose value and Scotland becomes less attractive as a destination and funds look elsewhere – this will further depress the market”.

“Without investment and with public sector resources stretched”, he warns, “what activity there is confined to small lots or few high-end deals.”

Finally, the continued polarisation of the property markets between prime and secondary/tertiary locations “means ultimately that the sector cannot drive economic development through new development and jobs creation to the extent of its potential”. Both the public and the private sectors will be losers.

The challenges are formidable. But for all the headwinds, the outlook for the commercial property sector is not as bleak as commonly assumed. There are dynamics working towards an improvement in sentiment that should help the sector over the next three years.

This is not to gloss over the immediate challenges ahead – and the conference will be preoccupied with those. The theme is: “Recovery – How can Scotland Deliver?” Key topics include an all-too-familiar list of concerns: planning fees and reform for developers; continued pressures on property finance; the Scottish Government Review of town centres, more building standards for new build and “retrofit” for residential and commercial landlords and business rates and Scotland’s Land & Buildings Transaction Tax.

So what are the positive points? First, among the debris, there are signs of life – industrial and distribution centres are seen as “rising start” sectors. There are also flickers of improvement in construction as those fabled “shovel-ready projects” finally get underway. Latest figures last week showed construction order volumes rose by 3.4 per cent in the fourth quarter of 2012, taking the year-on-year increase to 11.2 per cent.

Though this improvement has come off a very low base, latest gain was widespread, and lifts hopes, says Global Insight economist Howard Archer, “that the sector’s problems may have bottomed out”. In January employment in the sector edged up and business expectations among construction companies improved to a six-month high.

Second, the growing dilapidation of town and city centres as internet retail marches on will intensify pressure for redesign, rebuild and refurbishment. At the same time rising energy costs will intensify a residential move back into urban centres.

A key prop to commercial property investment UK-wide has been the activity of overseas investors. They were by far the largest buyers of UK property last year. This investment interest should intensify with the recent weakness of sterling.

Also working in favour in property is that, with the rise in rental yields, commercial property offers a significant attraction over gilts, with the ten-year gilt yield still down at 1.75-2.0 per cent compared with property yields of between 6 and 7 per cent.

A continuing, gradual improvement in the supply of mortgage finance should help. The Royal Institute of Chartered Surveyors struck a slightly more positive tone in its recent housing market forecast.

On commercial property the Institute is altogether more cautious, forecasting that both capital values and rents will be broadly flat over the course of the year. “Given the macro backdrop, it is hard to see a significant narrowing in the gap between the performance of prime and secondary real estate.” However, the sector should not overlook the positive dynamic of innovation and new technology in providing a spur to activity over time. In the housing sector, building standards and energy efficiency have improved dramatically over the past ten years, which should help spur both private buying activity and local authorities in social housing development. The sector’s problems are not to be minimised. But there is reasonable prospect of improvement for the patient.

Twitter: @Bill_Jamieson