Gerald Eve warns of continued disconnect between investment and occupier markets (UK)

Gerald Eve's latest investment brief forecasts highlight a stark dichotomy of current property market fundamentals – it offers an all property total return forecast for 2010 of 14.7% but a fall in property rents forecast of -1.4% for the year.

Gerald Eve, which advises 40% of the FTSE 250, says its at first sight optimistic total return forecast is largely driven by yield compression in prime mainly London assets. These properties are still seen as a safe haven not only for the wave of international investment but also domestic investors, notwithstanding the vulnerable state of the UK economy in general. Overall rental values are still 11% below their peak in April 2008. However given the fragile nature of economic recovery and potential double dip, Gerald Eve says that there is considerable uncertainty and material rental growth will remain elusive for some time to come.

Gerald Eve's Head of Investment Research Robert Fourt says: "The modest improvement in some economic figures must be off set by continuing recessionary impacts on the occupier sector which in turn will affect the prospects of rental growth. At present there is a clear disconnect between the investment and occupier markets of which one explanation is the weight of money pouring into prime assets and central London - the real safe haven - rather than overall property fundamentals."

London offices are expected to be the biggest beneficiaries of what rental growth there is, because of limited supply and a lack of new development. Gerald Eve predicts West End offices will see rental growth in West End offices of 3% in 2010 rising to 6.6% in 2011 and dropping marginally to 6.1% the next year. In the City it is forecasting rental growth of 3.1% this year, 6.4% next year before falling to 5.7% in 2012. (These rents apply to the all property rents not prime rents.)

Industrial and shopping centers bring up the rear in rental performance. Gerald Eve predicts a fall in rents for shopping centers this year of -3.5% and -1.5% in industrial rents. Shopping center rents will see growth of 1.1% in 2011 rising to 1.9% in 2012. Industrial rents are barely predicted to grow with just 0.1% growth in 2011 before a pick up of 1.5% in 2012.

Given the reduction in yields over the last quarter Gerald Eve has revised upwards its all property return figure from 12% in its spring forecast to 14.7% for 2010. It feels anticipated yield levels at the end of 2010 are likely to make UK property look less attractive to other asset classes including European property with the result there will be less scope for yield reduction in 2011 and 2012.

Fourt adds: "Interest rates are likely to be increased at some point early next year, possibly even as early as later this year, subject to inflation and the fragility of the economy. Add to this property pricing relative to gilts as a result we anticipate a fall-off in total returns in 2011 of 7.1%, before recovery in 2012 of 10.2%."

City offices are predicted to deliver a total rate of return of 21.5% for 2010 before almost halving to 11% and 11.5% in 2011 and 2012 respectively. West End offices are predicted to achieve a total rate of return of 19.5% this year and then 10.4% in 2011 and 12% in 2012. Shops appear to be the sluggard in total return forecasts with 11.9% predicted for 2010 and then 5.2% and 7.9% in the following two years.

Source: MJ2

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