Secondary offices have been the ‘best performing sub-sector of the UK commercial property market’ during the past twelve months. That’s according to CB Richard Ellis (CBRE)’s UK Property Viewpoint for August 2011.
The commercial property and real estate advisers’ report paints an encouraging picture of the secondary commercial property market, albeit with caveats. The data is qualified with a reminder that commercial property ‘investors are likely to remain selective in moving up the risk curve’ while ‘capital market conditions’ in commercial property remain ‘cautious’.
Recent commercial property returns, post mid-2009, are found to be ‘characterised by declining momentum, with barely positive monthly capital growth’. Despite this apparent slowdown, commercial property values have still increased by 3.7%. According to the CBRE Monthly Index, which records monthly valuations of residential and commercial property, this is down on last year’s increase of 17.8%. However, these figures, coupled with an ungeared total return of 10.1%, have managed to deliver performance ‘more or less in line’ with commercial property investors’ expectations.
The recent commercial property trend is reported to be taking ‘UK commercial property values back only to their October 2003 level; as at the end of June 2011 All Property Values remain 31.6% below their previous peak in mid-2007’. For the commercial property market to get back to this peak, CBRE expects this ‘to be a very protracted process’ and does not expect this to happen within the next five years.
Splitting the UK commercial property market into sub-sectors, CBRE places Central London offices as ‘by far the strongest’ performer. Values rose by 12.5%, following on from the previous year’s 26.5% jump in commercial property capital values.
Retail warehouses are the second best performing commercial property sub-sector. Values rose ‘by a more modest’ 4.7% during the year.
Outer London/M25 and regional office markets saw 1.1% and 4.6% falls respectively, detracting from the previous years’ gains.
Looking at the past two years, All Property values register a 22.1% increase. Central London offices have the largest rebound at 42.3%, followed by 35.4% in retail warehouses. Regional and South East offices climb 0.5% and 5.1%.
CBRE looks at ‘underlying performance data for individual properties’. This reveals ‘some degree of catch up for the average and good secondary assets represented by the broader’ CBRE Monthly Index. Capital growth of 10.3% in secondary offices and rental growth of 2.6% ‘also had a positive impact’. These figures are ‘atypical’, according to CBRE, who says that, in general, among secondary commercial property markets ‘the weakness of occupier demand has seen further reductions in rental values, which continue to act as a drag on capital growth and returns’. This is in contrast to the prime commercial property market, where ‘rental values have stabilised and are now showing positive growth’.
But, where does this commercial property optimism for Central London’s secondary offices come from? CBRE explains this ‘can be attributed in large part to the very specific circumstances of that market; the prospects in the underlying occupier market are much better than in other secondary markets, and rental growth has returned there.’ Yield impact for secondary Central London offices is recorded as 7.4% while the next best performer is industrials with 4.7%.
In nearly all other secondary markets, rents are described as continuing ‘to decline and growth is likely to be some way off yet’. This is exemplified by the Rest of UK Offices sector return in yields – a negative of -2.1%.
Commercial property performance across prime markets ‘was more mixed than in 2009–10, when all prime sub-markets saw some degree of positive growth’. Commercial property gains were noted in Central London offices, shopping centres and retail warehouses. The regional commercial property market for offices fell. Over the year, prime commercial property values ‘more or less held their own’ in retail and industrial markets.
The research concludes: ‘the evolution of the prime and secondary markets over the past year has continued to conform broadly to the pattern seen since the onset of the market recovery; investors are still primarily focussed on better quality assets with longer term secure income.’
Do secondary commercial property markets appear to have an advantage? CBRE draws attention to the ‘fact that returns in the prime markets are now relatively constrained and increasingly dependent on improvements in rental growth’. As detailed above, secondary commercial property markets have returned higher yields which is deemed ‘on the face of it to look increasingly attractive’. The difference between prime and secondary commercial property ‘does indeed point to a narrowing’ in performance.
What about investment risks in secondary commercial property markets? CBRE may tip Central London secondary offices for a potential recovery, but advises caution elsewhere. Prime commercial property may appear to have performance limits in the short term, but CBRE warns that: ‘the risks in the secondary markets as a whole remain substantial. Aside from the question of income security and re-letting risk, the weak pace of the economic recovery is likely to delay any improvement in occupier demand, at the same time as reducing the availability of debt finance and tightening lending standards.’
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