UK commercial property records -4.0% capital value change in Q3 September rental value growth for All Property increased by 0.2%, feeding in to total returns of 0.3%. Across Q3 2016, capital values decreased by -4.0%, a reversal of than the Q2 growth of 0.5%. Office sector capital values have fallen by -5.1% in Q3 versus growth of 1.0% in Q2, showing a significant fall in values since the EU Referendum. Capital values for the Industrial sector fell by -2.2% over Q3, with the sector experiencing a less severe Brexit impact.
H1 2016 UK Office Market Overview - key takeaways: UK GDP forecasts have been revised down following the EU Referendum result. However, the outlook is still one of growth, albeit at a slower rate. A recession is not anticipated. The market and the economy is very much sentiment driven at the moment, which can make firm predications difficult. There was a varied picture of occupier demand in H1 2016 in the core regional markets. Some cities have had a strong start to the year, whereas others have struggled relative to recent past performance. Cities with improved levels of take-up this year, compared to 2015, include Bristol, Glasgow and Liverpool. Against each city’s five year average Birmingham, Edinburgh and Southampton can also be added to the list of cities performing above trend over the course of the last six months. Transaction activity is continuing. Few occupier deals have yet been lost due to the EU Referendum result. The only exceptions are a few deals where ‘Brexit’ is being cited as the explanatory factor for pulling out of a transaction – but in fact there was some other underlying issue. Investor appetite for regional office markets was surprisingly strong in H1 2016, with approximately £2.2 billion spent on offices around the UK, beyond London and the South Eastern regions.This level was around £200 million up on the first half total of 2015. Given uncertainty around the political and economic outlook it is not surprising that some market participants have put major decisions on hold until there is more clarity and evidence of any impact on property pricing. However, good quality real estate with a long, secure income stream (which is exactly what property funds invest in) is likely to remain attractive to investors.
Take-up fell by 48% to 537,800 sq ft over the course of the month, 49% below the 10-year average of 1.0m sq ft. Availability increased by 1% to stand at 13.8m sq ft, still well below the 10-year average of 14.6m. The Central London vacancy rate increased by 20bps to 3.5%. Under offers fell by 3% to stand at 2.9m sq ft. A total of 1.9m sq ft of development and refurbishment space has completed so far in 2016. A further 4.6m sq ft is expected to complete before the end of the year.
Our first post referendum vote release of yields is set out below. • Immediately after the vote, the sector was marked out as one that would be comparatively robust. Whilst values have slipped in most commercial markets over the last 3 months, the residential investment sector seems to be holding its own, albeit with lower levels of activity and some weakening in secondary markets. • Manchester continues to appeal to investors with LaSalle announcing its acquisition of Greengate, M&G forward funding its first scheme in the region at Port Street plus Glenbrook/Moorfield and Delph also making acquisitions. • Other headline activity saw the Europa Capital & Addington Capital Joint Venture acquire Velocity Village in Sheffield and L&Q forward fund a scheme in Acton. • The possibility remains of potential deal renegotiations pushing yields outwards in secondary locations over the next 3 months.
For Q3 2016 originations, Senior CRE lending returns are forecast to be 3.1%pa on a gross basis and 2.8%pa on a risk-adjusted basis. This represents no change on Q2 returns. The previous quarter’s estimated 25bps rise in margins reflected weakening sentiment in the final week of June after the Brexit vote. That senior margins have been flat over Q3 2016 reflects in many ways a quicker return to “normality” than was thought likely three months ago. There was only a very slight fall in 5yr swap rates of 6bps over the third quarter. A modest improvement in the forecast for capital growth resulted in a very slight decline in Probability of Default and Expected Loss over the third quarter. The key measure for banks, Return on RWA (calculated here as a function of margin and fee alone), was largely flat. On an RoRWA basis, gross returns were 3.5%pa and risk-adjusted returns 2.9%pa, assuming Strong slotting treatment. Senior CRE lending continues to offer a healthy premium of 2.5%pa to the risk-free rate, on a risk adjusted basis. Against corporate debt, the relative return offered by senior CRE debt improved further over Q3 to 1.8%, the highest level for almost two years. Spreads on CMBS narrowed a little, making senior CRE lending look slightly more attractive versus this asset class than three months ago. On a risk-adjusted basis, CRE debt arguably offers significantly more attractive returns than ungeared equity. This is particularly true of some key segments, including London offices.