Warming Signs in U.K. Commercial Property

About a year ago, observers of the UK commercial property market would not have been shocked to see the Four Horsemen of the Apocalypse riding around the corner.

The banks would not (and, indeed, could not) lend, companies were not looking for office space, particularly in London, and firms that would consider signing new leases were only looking for short-term agreements, on smaller offices. Those that can recall the demise of Woolworths can guess what retailers thought of taking on more space.

The property market slump had long been signalled. Two years ago, the Royal Institute of Chartered Surveyors (Rics) fired a shot across the bows of the industry, warning that demand for buying and letting commercial property had fallen to a four-year low, stoking fears that the sector was heading for a depression not seen since the early 1990s.

The collapse of Lehman Brothers last September, and the demise of banks such as RBS (RBS), made matters worse, with hundreds of millions of pounds wiped off the value of real-estate investment trusts, or Reits.

Companies including British Land (BLND.L), Land Securities (LAND.L) and Hammerson (HMSO.L) have spent much of the last year writing down property valuations and pulling the sales of assets as potential buyers decided to put deals on ice, hoping to judge the bottom of the market. It appears that those buyers still waiting have now missed out. Little more than a year after many in the industry were calling Armageddon, the picture could not be more different.

Flows into unlisted UK property funds hit £704m in the third quarter, the largest quarterly amount in two years, data from the Association of Real Estate Funds showed earlier this month, while the respected Investment Property Databank's monthly index of commercial property values rose for a third straight month in October. The jump of 1.9 per cent came after the index grew 1.1 per cent in September. The index had fallen 44 per cent since highs in valuations seen in mid-2007.

Peter Damesick, the head of UK research at CB Richard Ellis (CBG), the commercial real-estate advisory group, argues that the recovery seen in recent months is largely due to investor confidence returning. "Property values stabilised over the summer, which indicated to most investors that the rock-bottom level for prices had been reached," he says.

"With yields at around 7.5 per cent, which is much higher than you can expect to get in the equity or bond markets, there has been a lot more money being invested in the sector, which has increased confidence among other investors. The fact that the big quoted companies have worked hard to cut gearing and have recapitalised has also helped."

One of those companies, British Land, published half-year results yesterday, posting its first rise in net asset value (NAV), the key measurement of success in the industry, for more than two years. The group's chief executive, Chris Grigg, said that his company was seeing improvements. "In the first quarter, we saw valuations continuing to fall, but the second quarter has seen some more reassuring developments," he said. "This reflects growing confidence in the sector generally, and while the market is still difficult to call, you'll start to see us being busy in the market over the next 12 to 24 months."

British Land said its NAV was up 3.1 per cent to 372p a share in its second quarter, helping to offset the 6.5 per cent fall seen since March. The group has seen 70 per cent of its £8.3bn portfolio increase in value since June. Later today, the UK's biggest Reit, Land Securities, is likely to underscore the improving nature of the market when it publishes its half-year numbers. Land Securities' shares have put on 53 per cent in the last six months, while British Land's stock has grown by 29 per cent.

Chris Grigg suggested yesterday that British Land's improved fortunes were "testimony to the quality of our portfolio and strength of management." That is no doubt true, but a number of other factors beyond the company's control have also helped.

Historically low interest rates have allowed some that would have have faced crippling interest charges to hold on to assets, rather than swamp the market with property at fire-sale prices. Likewise the banks, which were hit last year largely because they took on far too many property assets of questionable value, have not rushed to offload toxic assets either.

"The banks have been keen to avoid crystallising losses on their property books and so have not flooded the market with emergency sales," says Oliver Gilmartin, a senior economist at Rics. "They have been careful to manage assets off their balance sheets carefully, which has aided stability."

Despite the strides made over the last few months, and the major players in the industry making plans for investment rather than worrying about further write-downs, some in the industry warn that there could still be trouble ahead.

"Recent price rises have largely been driven by the shortage of supply. While there are many potential buyers of commercial real-estate, at the moment not many people want to sell. In addition, real drivers of value are still weak," says Jonathan Thompson, head of real estate and building at KPMG. "Reduced spending by consumers, along with business failures, is driving down occupancy and rental rates; would-be renters and purchasers of commercial property are still in short supply.

"The biggest problem is perhaps the record amounts of outstanding loans secured on commercial property globally. While the outlook is slightly rosier than a couple of months ago a real recovery of the sector might not yet be around the corner," he said.

Minerva offer: Developer rejects 50p-a-share bid

City of London property developer Minerva (MNR.L) yesterday rejected a cash bid from its biggest shareholder that values the group at £84.5m. In further evidence that the UK's commercial property market is thawing, KiFin, an investment firm controlled by South African businessman Nathan Kirsh, offered 50p a share, representing a 31 per cent premium to Minerva's closing price of 38.25p on Monday evening.

Minerva's board rejected the offer, which they said "significantly undervalues the company", adding that the bid was "opportunistic and unwelcome". The market reacted yesterday by sending Minerva's shares up by 42.18 per cent to close at 52.25p, slightly ahead of Mr Kirsh's offer. It is not the first time Minerva has attracted bids. In July last year, Dubai Limitless, a sovereign wealth fund, offered 160p a share, but withdrew after failing to win the backing of the developer's lenders. Minerva's two biggest developments – St Botolphs and Walbrook, both in the City – are expected to open next year.

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