Whilst paperâbased assets have been plunging in value, UK property prices have been holding up. Just about.
OK, Iâm not talking about the residential housing market. Itâs commercial property values that have been nudging slightly higher this year. Last month they crept up by a further 0.1%, says the Investment Property Databank index.
So what should investors expect next?
Commercial property has been an investment disaster zone
Average values in Britainâs commercial property sector â thatâs offices, warehouses and shops â have now climbed by some 17.5% since their lows in the summer of 2009. And some parts of it have enjoyed something of a purple patch, central London office space in particular.
But letâs get this rise into perspective. Sector prices are still down by almost 35% from their mid-2007 highs. Since that top for the UK commercial property market, shareholders in quoted real estate investment trusts (REITS) have lost almost 70% of their money. Indeed, investors in the sector have made hardly any capital gains overall since 1993. (You can compare that with the performance of UK housing over the same time, which you can track at the UK house price page). But perhaps commercial property prices have been in the doldrums long enough to interest possible bargain hunters. After all weâve been long-term bearish about this market for ages. So should we now think about changing our tune?
Certainly not yet. For starters, the pick up in prices appears to be losing steam. Last month saw the smallest improvement in overall values since the recent recovery began in 2009. Indeed, over the last year, capital growth in commercial property has slowed to just 1.9%.
And, like the London residential market, the rebound in commercial values since 2009 has been as much about a shortage of decent buildings coming available, as any major surge in buying.
The sector still faces problems
But thatâs currently changing. And not in a good way for prices. As Kelvin Donaldson at Capital Economics notes, âanecdotal evidence suggests that due to the lack of high quality standing property for sale, investors are increasingly buying low-grade properties with the intention of refurbishing them before selling or lettingâ.
That will mean more supply on the market, even though itâs not showing through in the official figures yet.
Then thereâs building activity in the sector. The most recent business survey evidence, the construction purchasing managersâ index (PMI), suggests this has continued to grow steadily in July. On the surface, that implies rising confidence in commercial property prospects. Further, the PMI has been a handy historic guide to future changes in rental values. So you might expect these to continue to get better.
But the problem for the sector now is that with credit still tight and banks unwilling to lend, neither improvement may last much longer. As Davidson says, âa slowdown in commercial property construction in the second half of 2011 seems more likely than a pick upâ. That would be a bad sign for rental levels.
The worsening economy wonât help
Last month, Ambrose Evans-Pritchard pointed out in the Telegraph that âBritainâs household finances have deteriorated to the lowest point since the depths of the recessionâ.
Since then the Misery Index, which adds together the jobless rate to the rise of our cost of living to measure the level of financial pain the country is suffering, has just hit its highest point in over 17 years.
You can read all about this here: A share to cheer you â despite the Misery Index. Itâs all bad news for landlords. The growing squeeze on disposable incomes will mean less cash being spent in Britainâs shops. Thatâs likely to lead to more pressure on retailersâ cash flows. So property owners will be forced into agreeing more rent âdealsâ with these tenants, ie rents will be reduced.
Even that may not prevent another round of retail store failures, which would reduce landlordsâ incomes anyway.
And it wonât just be the shop sector that feels the pinch. Government spending cutbacks will increasingly cut demand from the public sector. Meanwhile, British industry is unlikely to need more warehouse space.
And with the banks now much more into firing than hiring mode, theyâll need less office space in the future. This will hit one of the marketâs bright spots. The recent upswing in Central London values and rents could soon go into reverse.
A money-making opportunity
By now youâre probably getting the picture â weâre not too keen on the market for the foreseeable future. But there is still a way to make money from it. However bad things get, it will still have to maintain insurance cover on its buildings. So why not buy shares in the countryâs largest property insurer?
RSA (LSE: RSA) is one of the worldâs leading insurance groups. It writes business in 130 countries, and provides a range of insurance products for over 20 million customers. So the firm has reduced its overall level of risk by diversifying widely.
RSA looked good value even before this monthâs equity market falls. But as its share price has been dragged down by everything else, it is becoming one of that exclusive club of stocks with p/e ratios lower than dividend yields. RSA is now on a current year p/e of just eight, while the prospective yield is 8.3%. Thatâs well worth tucking away.
Category: Market updates