Derivatives: Expectations of 14.5% fall in capital values by December 2015

All sectors except offices ended last year in negative growth territory – and even offices are feeling the squeeze

CBRE-GFI market commentary

IPD’s UK Annual Property Index Estimate finished the year on a negative note, writes Sam Whitham. Capital growth showed a further fall of 0.12% in December, the second consecutive month of negative growth. With monthly figures combined, the fourth quarter saw negative capital growth of 0.12% – the first quarter in negative territory since Q2 2009.

Offices continued to provide positive growth in December, the only sector to do so. Growth of 0.13% was fuelled by the West End, where capital values rose 0.7%, driven by restricted supply. For the first time in 27 months, City offices experienced a fall in values, by 0.1%.

The retail and industrial sectors both saw capital values fall – by 0.28% and 0.11% respectively. Regional variation continues over the two sectors, with London and the South East holding up more resolutely than the rest of the UK.

The IPD UK Index Estimate gave the annual total return as 7.38% – significantly lower than the most recent derivative trade price, of 7.8%, in late December. However, the IPD Quarterly All UK Index figure in September was roughly 40bps higher than the annual estimate, which may explain the discrepancy. With quarterly valuation accounting for 85% of the annual index, it is seen as a more accurate representation of where total returns will be for the annual index, revealed next month.

IPD contract pricing has fallen during the last month for each of the five years that are traded. The back end of the curve has fallen more sharply than the front, but total return expectations have fallen across the board. 2011 contract pricing was 15bps higher four weeks ago and now has a mid-price of 7.75% total return.

2012 contract pricing started the month at 1% total return and finished the month at half that level, 0.5%. At the back end of the curve, 2013, 2014 and 2015 total returns are now priced 70bps lower, at 3%. If derivative pricing were to be correct, capital values would fall by roughly 14.5% by December 2015.

Fund managers are now starting to look seriously at the option of buying IPD notes.  A two-year IPD linked note would be issued at par and provide IPD total return plus 1%. For those looking to outperform IPD, this is an extremely attractive option.

The final price for the 2011 Halifax House Price Index was released in early January and showed a 2.3% fall in the average UK house price over the year. The December number was down 1.86% on the month, and a total of 2.82% on the quarter. This is the second consecutive year of falling house prices, with derivatives predicting further falls. Current pricing suggests that house prices will not recover to their current level until 2015.

On a monthly basis the Halifax house price fluctuated during 2011, but resulted in an eventual 2.3% decrease. Looking forward to 2012, Halifax housing economist Martin Ellis stated: “If the UK can avoid recession, we expect broad stability in house prices in 2012.” However, 2012 contract mid-pricing of 95% suggests growth could be stunted for another year.

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