U.K. Commercial Property May Drop 4.9% in 2012 on Debt Crisis

U.K. Commercial Property May Drop 4.9% in 2012
Employees at Standard Chartered Plc are seen working at the company's office in London U.K., on Nov. 11, 2011. Photographer: Simon Dawson/Bloomberg

U.K. commercial property values probably will fall by 4.9 percent next year as the European debt crisis and concern that Britain may slip back into recession hurts demand for assets in all but the best locations.

Six economists, analysts and executives surveyed by Bloomberg News all predicted a decline in 2012. Prices tracked by Investment Property Databank fell last month for the first time since July 2009. The biggest drop estimated was 7 percent and the smallest was 2.5 percent.

“Businesses are not feeling confident,” said Ed Stansfield, chief property economist at London-based Capital Economics Ltd. “They’re not investing, they’re not employing, none of which is good news for the commercial property sector.”

A two-year recovery in values for U.K. shops, offices and warehouses petered out in the second half of this year as efforts to shore up the finances of countries such as Greece, Spain and Italy failed to stem rising government borrowing costs. The British economy has a 50 percent chance of slipping back into recession next year, the National Institute for Economic and Social research said last month.

The average value of U.K. commercial real estate declined 0.02 percent in November from October, IPD said on Dec. 14. Values fell 44.1 percent from June 2007 to June 2009 and then rose by 17.9 percent in the following months through November.

A forecasting model used by IPD suggests the market will fall by slightly more than 4 percent in 2012 before rising by less than 0.5 percent the next year, said Malcolm Hunt, the data company’s client services director for the U.K. and Ireland.

Avoiding Risk

In periods of economic uncertainty, investors and tenants tend to focus on buildings in the best locations “and away from the secondary, more risky areas of the market,” Hunt said.

Non-prime asset prices are under pressure as lenders such as Lloyds Banking Group Plc and Royal Bank of Scotland Plc seek to reduce their loan books by selling repossessed real estate or portfolios of loans. Also about 4.8 billion pounds of loans linked to commercial mortgage backed securities are due to mature next year, Standard & Poor’s wrote in a Nov. 30 report. That means the loans must be refinanced or the assets backing the commercial securities must be sold.

There’s a mismatch between the “pretty poor quality” assets backing bank loans coming due and the kind of properties sought by those with cash to invest, Stansfield said. Insurance companies and pension funds entering the real estate lending market only want to fund “high quality assets in prime and near-prime locations,” he said.

U.K. real estate investment trusts with high-quality assets will benefit from that preference, said Sue Munden, an analyst at investment bank Seymour Pierce Ltd. “The good are going to continue getting better and the bad are going to carry on getting worse,” she said.

Rich Get Richer

Munden predicted that other property companies will follow Derwent London Plc in issuing convertible bonds as an alternative to bank financing.

The value of larger U.K. property companies such as Land Securities Plc may increase by 20 percent next year, leaving them trading at a discount of about 10 percent to net asset value, said JPMorgan Chase & Co. analyst Harm Meijer.

Munden is advising clients to focus on companies with assets in London such as Shaftesbury Plc.

“In order for rents to rise, you need the economy to be positive, to have GDP growth, and London is probably the only area in the U.K. that has remained buoyant,” she said.

Retail is the weakest area of the market and IPD expects that to remain the case until 2013, according to Hunt. Stansfield said Capital Economics currently prefers warehouses.

“There’s a marginal preference for the industrial sector,” he said. “It’s not a positive bias in favor of it, it’s rather that it’s the best of a bad job.”

Takeover Targets

The market may also see more publicly traded real estate companies being targeted by for takeovers, said Meijer of JPMorgan. “We wouldn’t be surprised if an overseas REIT comes sniffing around. The U.K. small caps look pretty vulnerable.”

He predicted that values will fall by 3.5 percent by the middle of next year, with non-prime assets dropping the most. Development Securities Chief Executive Officer Michael Marx predicted a drop of as much as 5 percent in the first half, with a possible rebound cutting the decline to zero to 2.5 percent for the full year. Stansfield estimated a 5 percent decline for 2012.

U.K. commercial properties are still more than a third cheaper than they were at the peak of the market, said Hunt at IPD. “Although we’ve talked about the end of a recovery, we’re still a long way shy of where we were.”