Operating Review
Print this pageAdjusting our focus in response to the market to drive performance
The world in general, and the UK commercial property market in particular, seem non-committal as to the future direction of their markets.
They may also simply be exhausted. It is nearly three and a half years since the banking crisis began, and there is still no apparent let up. A return to the comforts of the old normality looks as far away as ever. As is apparent from the still gathering fiscal storm in the peripheral nations of the Eurozone, policy is still struggling to get on top of the liquidity and solvency issues that lie at the heart of the crisis.
Financial markets theoretically discount the future into today's prices. However, they have been, to date, strangely schizophrenic. Anyone who bet on inflation and economic recovery, buying gold, equities or inflation-linked bonds, made good money in 2010. Likewise, bets on deflation, namely nominal government bonds, have also paid off. This apparent conflict reflects the uncertainty felt by market participants as to whether the continued global economic recovery, which the equity markets are discounting, is built largely on government stimulus.
Against this backdrop, it is somewhat surprising, given the degree of current inflation and currency depreciation in recent years, that ten-year gilt yields are still under 4.0 per cent. This reflects both the impact of quantitative easing and a belief that the UK deficit will be brought under control in the medium-term and inflationary trends can be suppressed.
However, there is a degree of risk that the present low bond yields may be coming to an end in response to improving economic trends and rising inflation. Lenders are starting to seek higher returns on their funds, and if longer-term rates climb this could have implications for property yields.
Property values continued to rise during 2010 against the market’s predictions, as investors sought to deploy cash earning a minimal return. However, much of this growth was front-loaded and the second six months of the year saw most values track sideways.
We believe that markets will continue to undulate in response to the latest economic news. Economic stimulus from governments and resilient demand from Asia should allow a continued slow and patchy recovery. It is imperative that we recognise the swings in sentiment and adjust tactics if appropriate.
This recovery should translate into commercial property values overall being flat in 2011, with prime values up a little and secondary easing, making asset management the key to differentiation in performance. Slow economic recovery is not conducive to a swift return to rental growth, and this remains the case with rental values in all sectors apart from Central London. We believe it will be 2012, at the earliest, before the wider market will witness positive growth trends. In addition, shortening lease lengths and the slow unpicking of risk will impact on assets with short-term lease events.
The need to drive business performance by intensive asset management has prompted us to move our focus further up the 'risk curve' and deploy our full range of value add skills. Taking advantage of the lack of liquidity in the secondary market, and the resulting favourable pricing of assets, we have secured a number of projects where we are planning extensive refurbishment or redevelopment, in order to create institutional-grade investment stock.
At this point in the property cycle, major development requirements are naturally few. Those that have arisen have been almost exclusively in Central London. We have reviewed several opportunities, and submitted bids on some, but we have been outbid by others with perhaps a more bullish view of medium-term occupier demand.
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