Better than average’ returns will be achieved with good stock selection but delayed investments could miss the upturn
A mid-year update from LaSalle Investment Management (“LaSalle”) on the European commercial real estate market reveals that investor sentiment has stabilised and that re-pricing has found a floor. There is also evidence, according to LaSalle, that there is increasing competition, particularly from foreign buyers attracted by the weakness in Sterling and the benefits of the UK lease, so investors need to move quickly to avoid missing the upturn.
The 2009 Mid-Year Update follows the publication in January of the 15th edition of LaSalle’s Investment Strategy Annual, a comprehensive survey of, and outlook for, the global real estate markets, which correctly called the market at that time and recommended a focus on retail rather than offices.
LaSalle believes that occupational demand prospects look bleak across all commercial real estate sectors, but despite lower consumer expenditure, retail still provides the best investment prospects due to its defensive qualities. It says that good retail property is much more lettable in a recession than an office or warehouse as there is always a retailer looking to expand, even in tough times. In contrast, businesses will do everything possible to avoid taking new office space in a recession. LaSalle cites the successful letting of former Woolworth stores in the UK as proof of the adaptability of retail property at a time when office and warehouse vacancies are rising sharply.
Looking to 2010, investors should capitalise on the reversion to more sustainable pricing though deals acquired today will need to withstand declining rental values, says LaSalle. This can be achieved through having a long lease that secures cash flow through the downturn and/or because the property is so attractive to occupiers that it will weather the recession without this protection. Correctly identified opportunities (appropriate lease structures and tenant covenants) will be able to cope with the general decline in rental values over the next five years.
However, according to LaSalle, there are stock shortages in some sectors and when occupational markets recover, rental growth could quickly follow. But it warns that without active asset management, rental income will decline, with secondary assets likely to bear the brunt of these falls.
The UK IPD Index will continue to remain weak into 2010, principally due to falling rents, especially for secondary quality assets, before recovering sharply as prices become increasingly attractive relative to other asset classes.
Report co-author Robin Goodchild, LaSalle Investment Management’s Head of European Research and Strategy, says: “There have been great opportunities emerging in the UK to acquire good quality real estate at attractive prices, particularly from REITs. More of these opportunities are starting to appear in Continental Europe as banks begin to deal with non-performing loans and their REITs are increasingly squeezed by re-financing issues. In particular, cash rich investors who can react swiftly should benefit from the re-pricing. However, some of the best opportunities are likely to be in partnership with the banks because of their desire to avoid fire sales.
“Delaying investment decisions could materially increase the risk of missing the upturn as sentiment has improved markedly during the year. In the past, the yield recovery phase after a downswing has occurred over no longer than a two year period, and with better transparency and faster global capital, it is likely to be more rapid this time.
”We have already seen a number of overseas players enticed to the UK market by the fall in Sterling, including the Canadian Pension Plan for whom LaSalle has purchased a number of prime retail assets. In all these cases we have focused on high quality, robust cash flows and I doubt if we could buy these properties at as attractive pricing today.”
LaSalle says the debt markets remain highly restricted with lending limited to preferred long-term customers and trusted business models, and even then there are difficulties borrowing more than €50 million. Typical loan-to-value ratios on prime assets are now limited to 50% to 60% with no available financing for speculative developments.
