West End office yields fell over the second quarter, according to the IPD UK Quarterly Property Index, marking the first property segment to return to yield compression for more than two years.
Yield impact, which measures the influence of yield movements on capital values, was 0.9% over Q2 the first market segment to show positive quarterly impact since Q1 2007. Only sustained downward pressure on rental value levels, at -7.1%, therefore, prevented capital values rising over the quarter. This erosion of estimated rental value (ERV) was steeper than in any other segment last quarter, forcing West End office capital values down by a further -4.4%, despite the slight hardening of yields.
Despite this yield improvement since the turn of the year, West End offices have seen the largest segment disposals over the last two year years, with total sales worth £2.8 bln. (approx. 3.3 bln.) against £392 mln. in purchases the vast bulk of which was in the first quarter. Ownership in this sub-sector is thus increasingly dominated by overseas investors.
Excluding the 'other property' segment (which is a small universe of income-driven property types including pubs, leisure, hotels and health and education), downward pressure on rental levels is weakest in the Industrials, Standard Retail including supermarkets and Shopping Center segments. West End and City offices, while under most strain, are cyclical sectors and have historically bounced back with strong rental growth after a downturn.
At the broader market level, all property capital growth for the second quarter was -4.0%, as income returns improved for the fifth consecutive quarter ending June at 1.8%. The 12-month change in capital values is -29.6%.
Malcolm Frodsham, Research Director at IPD said: "A two-tier market has developed around externally and domestically-orientated markets. The externally focused cyclical Central London office market has begun its recovery as overseas equity investors target yield now that the inflexion point in rental trends has passed. Meanwhile, the domestic-facing retail and industrials sectors, plus the regional office markets, continue to suffer from falling rental values and weak demand from UK investors either unable to access debt or unwilling to make a significant asset allocation shift."