Investor pricing survey: Optimism looks short-lived as investors scale back 2011 expectations

Investors’ views about the property market in 2010 continue to improve, following more compression in yields, especially secondary ones. Respondents to the latest Colliers CRE/Real Estate Capital survey have upgraded total return forecasts, expecting less severe rent falls and positive capital growth. But they are less optimistic about 2011, predicting that capital growth will turn negative and lowering their expectations of total returns for next year. The survey, in its 16th year, is published three times a year and carried out by KASPAR Associates’ Dr Karen Sieracki.

Investment intentions: buy, not sell

Buying continues to be the story. Retail, investors’ favourite since November 2008, is still the top buy with 64% of respondents, followed by offices and industrial, at 57%. Central London, south-east and south-west retail were favoured by 29% of respondents. Sentiment towards offices improved, with 57% considering them a buy, compared with 54% in November. Central London offices remain the top pick, but are slightly less favoured than previously, at 36%, compared with 46% last time. Central London, southeast and south-west retail followed, all at 29%.

Polled on the best locations and sectors to deliver strong medium-term returns, given an anaemic UK economy, 79% of respondents picked central London offices, followed by south-east offices (50%), central London retail (43%) and south-east retail (36%). Half of those polled felt that now was the time for speculative development. Offices were the favoured sector, with 36% citing central London and 21% saying a prelet would be ideal. Another 28% thought speculative development should start from 2011 to 2013 and after.

Few respondents intended to sell property and it is several years since sale intentions have been so muted. This reluctance to part with assets could have implications for market liquidity, limiting availability of stock.

 Yields: secondary fall faster

Yields, which first started to fall in the last survey, continued their downward path. The average prime yield was 6.5%, 30 basis points lower, but secondary yields fell twice as much, by 60bps on average.

The biggest prime yields fall was 60bps for retail warehouses, to 5.8%, while distribution registered the smallest, remaining static at 7.2% – the highest yield of all sectors. Prime shop yields are still the lowest, at 5.4%.

Average secondary property yields fell to 8.0%, from 8.6% in November. Secondary retail warehouse yields fell furthest, by 110bps to 7.3%, while the smallest fall was 10bps for business parks, to 9.1%. Shops had the lowest secondary yield, at 7.1%, and business parks the highest, at 9.1%.

With secondary yields falling faster than prime yields, the gap between the two has narrowed. In absolute figures, distribution has the smallest gap, at 103bps, while shops has the widest, at 179 bps. The prime and secondary yields gap range has risen to 76bps (a 103-179bps range), after a 52bps fall in November (a 150-202bps range), indicating that expectations for secondary property performance have deteriorated.

“In light of continued rent falls forecast for 2010, pricing continues to be dictated by the capital markets, not property fundamentals,” says Sieracki. “Property pricing now depends on the level of interest rates, gilt yields and quantitative easing. If these change before 2011, property yields are likely to move out. “There is also an assumption that the economy will not deteriorate when quantitative easing and interest rates change. Pricing dictated by fundamentals is forecast to return in 2011.”

Rental growth: continuing optimism

Rental growth expectations for 2010 and 2011 continue to improve (see table). Rents are still forecast to fall this year, but by almost half of November’s prediction: a 170bps drop, rather than 333bps, on average.

The greatest positive change, 470bps, was for offices, where a 2.4% fall is expected, continuing the trend in the last survey. The least change was for industrial and distribution sectors (270bps for both). Business parks are forecast to produce this year’s worst rental performance, at -5.6%, while offices are expected to perform best, at -2.4%. Average rental growth for 2010 is being pencilled in at -3.4%.

Rental growth is likely to return in 2011, albeit at a muted 0.9%: an average rise of 177bps. But business park rents are forecast to continue falling, by 0.8% over the year. The office sector is expected to improve most (by 350bps) and to produce the best rental growth, at 3.4%. The smallest rises are predicted for shop rents, at 50bps.

“In relative terms, offices and business parks are forecast to improve the most from 2010 to 2011,” says Sieracki. “These are the sectors to target for better performance. The industrial sector is likely to improve the least.”

Capital growth: all values to rise in 2010

Capital growth forecasts for 2010 have also improved. Values are now expected to rise in all sectors this year, by 4.5% on average – a 461bps rise. The biggest rise, of 730bps, is expected for offices, returning the sector to positive territory. Offices are expected to register this year’s best capital growth, at 5.8%, and business parks the worst, at 1.9%.

In November, respondents predicted across-the-board rises in capital values for 2011. Now, they expect them to fall by an average -0.7%. Only two sectors are likely to show growth: offices at 0.7%, and retail warehouses, at 0.5%. Shops are expected to perform the worst, with 1.5% capital value falls. In relative terms, retail warehouses and shops are predicted to register the largest changes over 2010-2011, at 690bps and 680bps respectively, so will need the most care in terms of pricing. The smallest relative change is expected in distribution (420bps) and business parks (430bps), which could be seen as less volatile over the two years.

Total returns: better in 2010, worse in 2011

Investors’ total return expectations for 2010 rose to 11.2%, from 6.6% in November. Nearly two-thirds (64%) of respondents felt this was due to an investment rally, encouraged by capital flows into property. But the predicted 2011 total return fell to 5.6%, from 7.6% in November, with 43% of respondents citing slow rental growth and higher yields as the main causes.

Some 57% of respondents said property’s high income yield and relative cheapness relative to other asset classes made now a good time to buy. Investors are still wary of investing via vehicles, joint ventures or derivatives; 50% of respondents would not use these indirect formats. But this was less than the 62% who polled no in November. The 36% that said yes to indirect investment mentioned derivatives, REITs and joint ventures.

A vote of no confidence

With a general election looming, 43% of investors polled thought that a hung parliament would create uncertainty and worry the markets about the government’s ability to act, but they were not sure how long this uncertainty would last. The same proportion felt a Conservative majority would be positive in the short term. However, others were concerned that a Conservative government would cut expenditure too hard and too fast, causing the economy to experience a double dip. Nearly a third of respondents (29%) felt the property market would be indifferent to a Labour majority, but 21% thought property would do badly under Labour, predicting more taxes and less of a push for business, slowing the UK’s pull out of recession.