Commercial property upturn unsustainable says Ernst & Young's ITEM Club

Published 01st Feb 2010

The end of quantitative easing and banks’ ability to refinance loans could destabilise the UK commercial property market, according to Ernst & Young's ITEM Club In a special report released today the ITEM club said that UK commercial property prices rose 3% in December, their highest monthly rise in 23 years, but the chances of a sustained recovery in 2010 and beyond were unlikely.

The report said that the recovery could easily become destabilised because there was little sign of a pickup in market fundamentals with further upward movements in vacancy rates and downward shifts in rents throughout last year and "this trend looks set to continue".

Dean Hodcroft, EMEIA head of real estate at Ernst & Young, said: "“Welcome though the bounce of activity has been, its sustainability is far from certain. The upturn has largely been based on investors deciding the bottom of the market had been reached and the massive decline in prices over the past couple of years resulting in attractive buying opportunities.”

Andrew Goodwin, senior economic advisor to the Ernst & Young ITEM Club, also said: “Quantitative easing has also been a significant boost for the sector, with the Bank of England using this new base money to buy assets from the private sector, thus releasing liquidity and allowing these sellers to buy other commercial property assets.

“However, in the UK, quantitative easing is likely to end this week, and the Bank of England will no longer be buying assets from the private sector, with the likely result being that investors holding a greater proportion of their assets in gilts. Ultimately, this could result in the strong inflows into commercial property fading.

"On the positive side, ITEM has suggested the weak pound – which has lost around 25% of its value since 2007 – will continue to offer support for some time to come. The UK and London, in particular, will remain an attractive market for foreign investors looking to acquire trophy assets at depressed prices."

The ITEM club, which is the only independent economic forecasting group to use the HM Treasury’s model of the UK economy, said that property’s future is in the hands of the banks

Goodwin said: “Banks have given property companies a significant amount of leeway, but with a large amount of funding due to be re-financed imminently, and a proportion of that in negative equity or requiring a high loan-to-value ratio, a rise in default rates seems certain. This will further damage banks’ balance sheets and impair their ability to lend.

"This situation does leave a number of companies vulnerable and at the mercy of the banks, particularly when the time comes to re-finance. Some larger companies might be able to bridge the gap through an equity injection, but otherwise the banks are faced with foreclosing.”

However, it also said that supply constraints could buoy the market as there has been a sharp slowdown in new builds which will severely impact the supply of available property.

"However, this said, occupier demand and a plunge in office rents has been particularly severe in the more internationally exposed cities such as London and Amsterdam, where there is a higher concentration of financial service sector jobs," it said.

Goodwin said: “With occupier demand likely to remain weak across all market segments – as the UK economy stutters out of recession - and the possibility of the banks leniency and support for property companies waning, the most significant risks are all on the downside. It is difficult to see how the level of recent activity can be sustained.”

Source: ' PropertyWeek '

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