06. Februar 2012 
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The UK market turns, with the secondary sector teetering on the brink
Increased distressed asset sales may overwhelm the already struggling secondary sector in the UK real estate market. Prime growth was just 0.6% in the final quarter of 2011, whilst secondary assets lost -1.9% of their value, according to the IPD UK Quarterly Property Index.
These two sectors balanced themselves out to deliver a 1.4% total return in the fourth quarter, which contributed to a relatively robust return of 7.8% for the year. All property capital growth slowed to -0.1% in Q4, as investors questioned the outlook for rental growth amidst the onset of a potentially European wide recession. Optimism surrounding the discounted secondary sector, essentially yield based, may have failed to take into account the extent to which rents have fallen (-0.6% in Q4 alone, as opposed to 0.5% for prime) and the impact of excess supply from distressed loan book sales.
“Values, at the all property level, have stalled -30.3% from their 2007 peak, after a recovery of 21.0%. While this has avoided calamity, it has not been enough for banks to write back their bad debt loan books,” explained Malcolm Frodsham, Director of Research at IPD. “In the IPD dataset, which does not include what would be considered truly distressed assets, secondary values are still -42.7% below 2007. This is going to make the continuation of pretend and extend impossible, and increase forced sales, which has generated a lot of interest amongst less risk averse investors.
“But whilst initial yields in the secondary sector of 8.3% offer a high income premium (4.8% prime), banks remain unwilling to lend on assets without a secure tenant. Secondary property generally requires extensive investment and active management before becoming lettable, so it’s a catch 22 for investors trying to secure financing.”
Over the last year secondary sector level performance has been discouraging. Standard retail units have lost -2.5% of their values, shopping centres -7.7%. Office values in the South East have declined by -6.1% and in the rest of the UK by -7.7%. Retail warehouses and London offices were the only sectors to record positive growth in their secondary assets, of 1.4% and 5.3%.
Auctions data, that IPD releases in conjunction with Acuitus, indicates that private investors have shown increasing discernment across 2011, with yields expanding as pricing shifts ever downwards. In the short period between October and December 2011, the cPAD all property yield rose 70bp to 9.1%. Phil Tily, IPD UK and Ireland Managing Director, said, “There are reasons to be positive about the coming year. Total return for 2011 was 7.8%, considerably ahead of equities at -3.5%, while the initial yield, at 5.9%, was well above ahead of the premium offered on bonds, at 2.5%. These factors will keep attracting investors into the market.
“The solid return will also be of some consolation to the market as a whole, considering the amount of public and bank debt that rests on property.”
Asset diversification
The “other” sector – which includes leisure, healthcare and residential property - posted the strongest returns for the year, at 9.6%, ahead of retail (7.1%), offices (8.8%) and Industrials (7.4%). Unlike the conventional sectors, “other” assets saw steady returns in the second half of 2011 as the market tailed off. Capital growth in Q4 was still 0.6%. Heavy investment into the sector has seen it increase in size by 17.3% since December 2010.
Frodsham concluded,”Considering the state of the wider economy, there is still a degree of optimism surrounding the market. As always, careful asset selection and active management are going to be of considerable importance when considering distressed assets, but the stalled development pipeline does mean there is going to be increased demand for second hand space.”
These two sectors balanced themselves out to deliver a 1.4% total return in the fourth quarter, which contributed to a relatively robust return of 7.8% for the year. All property capital growth slowed to -0.1% in Q4, as investors questioned the outlook for rental growth amidst the onset of a potentially European wide recession. Optimism surrounding the discounted secondary sector, essentially yield based, may have failed to take into account the extent to which rents have fallen (-0.6% in Q4 alone, as opposed to 0.5% for prime) and the impact of excess supply from distressed loan book sales.
“Values, at the all property level, have stalled -30.3% from their 2007 peak, after a recovery of 21.0%. While this has avoided calamity, it has not been enough for banks to write back their bad debt loan books,” explained Malcolm Frodsham, Director of Research at IPD. “In the IPD dataset, which does not include what would be considered truly distressed assets, secondary values are still -42.7% below 2007. This is going to make the continuation of pretend and extend impossible, and increase forced sales, which has generated a lot of interest amongst less risk averse investors.
“But whilst initial yields in the secondary sector of 8.3% offer a high income premium (4.8% prime), banks remain unwilling to lend on assets without a secure tenant. Secondary property generally requires extensive investment and active management before becoming lettable, so it’s a catch 22 for investors trying to secure financing.”
Over the last year secondary sector level performance has been discouraging. Standard retail units have lost -2.5% of their values, shopping centres -7.7%. Office values in the South East have declined by -6.1% and in the rest of the UK by -7.7%. Retail warehouses and London offices were the only sectors to record positive growth in their secondary assets, of 1.4% and 5.3%.
Auctions data, that IPD releases in conjunction with Acuitus, indicates that private investors have shown increasing discernment across 2011, with yields expanding as pricing shifts ever downwards. In the short period between October and December 2011, the cPAD all property yield rose 70bp to 9.1%. Phil Tily, IPD UK and Ireland Managing Director, said, “There are reasons to be positive about the coming year. Total return for 2011 was 7.8%, considerably ahead of equities at -3.5%, while the initial yield, at 5.9%, was well above ahead of the premium offered on bonds, at 2.5%. These factors will keep attracting investors into the market.
“The solid return will also be of some consolation to the market as a whole, considering the amount of public and bank debt that rests on property.”
Asset diversification
The “other” sector – which includes leisure, healthcare and residential property - posted the strongest returns for the year, at 9.6%, ahead of retail (7.1%), offices (8.8%) and Industrials (7.4%). Unlike the conventional sectors, “other” assets saw steady returns in the second half of 2011 as the market tailed off. Capital growth in Q4 was still 0.6%. Heavy investment into the sector has seen it increase in size by 17.3% since December 2010.
Frodsham concluded,”Considering the state of the wider economy, there is still a degree of optimism surrounding the market. As always, careful asset selection and active management are going to be of considerable importance when considering distressed assets, but the stalled development pipeline does mean there is going to be increased demand for second hand space.”
