Precarious property recovery threatened by lack of debt finance and rising bond yields (UK)

The latest hard hitting investment brief from Gerald Eve presents a compelling narrative on the precarious nature of the recovery of the UK property sector. Gerald Eve says the property sector performed "one of the greatest turnarounds ever seen" over the last year. Capital values fell by approximately -12% in the first six months of 2009 before rebounding with gains of almost 10% in the second half of the year. And according to the IPD Monthly Digest all property capital growth was continued to appreciate with all property capital growth of 3.9% in the first quarter of 2010.

But the agent who advises 40% of the FTSE 100 warns two key elements strongly lead it to think that recent improved returns look to prove a "false dawn".

Robert Fourt, head of research at Gerald Eve says: "Firstly property debt and lack of financing is the elephant in the room. Prime assets or developments, largely in central London, may be able to attract finance for the time being, but outside of this narrow area property will be hard to finance, negative equity prevails and forced sales still remain a distinct possibility."

Secondly Fourt highlights that gilt yields have moved out noticeably. He says: "This may be due to nerves over the forthcoming election but, more likely the huge supply of gilts and the lack of quantitative easing to stimulate demand may see this trend continue."

Fourt adds: "The resulting rise in bond yields and the riskiness of UK plc will eventually feed through to property yields putting them under pressure to move out. Indeed this effect could be heightened if sterling does start to appreciate as many have been predicting. For many investors particularly outside the UK this could lead to a view that property is above fair value and that it would need to be re-priced."

Interestingly in light of its gloomy prognosis and the tough economic outlook Gerald Eve is actually less pessimistic than IPF consensus forecasts for rental growth. Gerald Eve predicts rental growth of -2.2% for 2010, 1.6% for 2011 and 3.3 in 2012 as oppose to IPF figures of -4.4%, 0.1% and 2.4% for the same years.

Over the period 2010-14 Gerald Eve anticipates higher average rental growth across all sectors with West End and City offices being the biggest beneficiaries with rental growth forecast at 5.8% and 5.2% respectively. This is partly because of the lack of new office space likely to come on to the London market.

Gerald Eve's total return figures are broadly in line with the IPF consensus figures for 2010 it is predicting 12% marginally down on the IPF's consensus all property forecast of 13.4%. West End offices lead with total rate of return forecasts of 13%, followed by City offices at 12.8% and industrials at 12.5%.

Fourt says: "The double digit returns in 2010 reflect our view of yield compression, due to a combination of the pressure of continuing demand and limited stock, across various sectors. But this has to be set into context with our concerns as to how sustainable returns will be through the year, particularly in the context of gilt pricing and property debt."

Over the period 2010-2014 Gerald Eve predicts an all property rate of return of 10%.

Fourt ends with a stark warning to fund managers: "Property is clearly no longer the one way bet it was before the financial crisis. There are, and will be opportunities across sectors, but spotting these in a volatile market is what will drive portfolio performance and bring into focus, far more starkly than was the case for the decade or so before the crash, underperformance. In other words there will be much less hovering around the benchmark."

Source: Brown Lloyd James Financial

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