“If you want to know what’s going on right now in the commercial property market, who do you ask?”, says David Stevenson on Motley Fool. Banks and estate agents are hardly the most objective of commentators, “So why not go straight to the horse’s mouth?”; namely, to the property companies that are buying and renting out office space across the country.
Shares in Land Securities and British Land are both down about 30% for the year, despite modest profit increases. Many analysts don’t expect them to recover soon, which is unsurprising, given that recent figures from the Investment Property Databank (IPD) showed that the monthly return from commercial property in July fell to its lowest in 12 years. Average total returns (that’s rent plus capital) came to 0.2%, with prices of shops and factories starting to fall.
Meanwhile, yields look unsustainably low. They’re now down from 6.8% at the end of 2001 to 4.5% in June this year, according to the IPD, meaning they “are now 1.7 percentage points below the cost of borrowing”, as The Economist points out. With commercial property yields now below those offered by gilts, investors could be forgiven for seeing little point in holding a fairly risky asset that yields less than a Government-backed alternative, particularly at a time when liquidity risk (how hard it is to sell an asset) is uppermost in everybody’s mind. Capital Economics reckons that commercial property prices will fall by 12% between the end of this year and 2010, as yields rise again. This is likely to be exacerbated by the fact that problems in the credit markets, caused by the US subprime crisis, mean that funding for real estate deals (and every other sort of deal) is getting harder to secure. That’s already led to some property deals being pulled, including a £1.1bn sale of hotels by RBS and the £300m auction of The Mailbox and The Cube leisure complexes in Birmingham.
This is, of course, having an impact on property funds. The New Star Property and Skandia Property funds lost 0.9% and 0.3% respectively in the six months to June 2007, whereas they made 7.4% and 7.7% in the same period last year. Property shares funds have fared even worse. Aberdeen Property Shares and SWIP UK Real Estate over the past six months have fallen by 15.1% and 18.4% respectively. And despite advice from independent financial advisors to hold onto shares, investors are piling out – in fact, The Sunday Telegraph reports that Norwich Property Trust is trying to discreetly offload some of its portfolio, as the proportion of the trust held in cash and shares has fallen to 15%, the bottom of the fund’s target level, as investors withdraw their money. Some argue that this is a buying opportunity, but we don’t agree. “Have real estate and [property] shares had their day in the sun? It looks like it and now it’s time to see who has been burnt. We are not quite at the point of maximum pessimism”, says Mike Prew, an analyst with Lehman Brothers. It’s time to sell, not buy back in.