A question of confidence

 

The commercial property market has enjoyed a resurgence in the past couple of years – but is change on the horizon? Lloyds Bank’s Martin Green, Managing Director, Commercial Real Estate and John Feeney, Global Head of Commercial Real Estate, look at confidence trends, and consider the challenges and opportunities they signal.

Martin GreenSince the second half of 2012 we have seen consistent strong growth in confidence around investment activity and open market values in all sectors of the real estate market – in the regions, and across both larger and smaller property companies. And while confidence remains far higher than it was two years ago, the latest Commercial Property Confidence Monitor1 (CPCM), published this month, confirms that a subtle softening is underway.

Confidence growth levels out

This 17th wave of the CPCM twice-yearly survey confirms several key trends currently in play.J Feeney

  • Overall investment is expected to increase over the next three to six months.
  • Confidence is high - but an increasing number expect activity to stabilise, and prices to stabilise in line with that.
  • An influx of foreign investment is perceived to have had a significant impact.

So while the rapidly increasing confidence of the last two years has far from evaporated, we should expect the confidence levels to even off over the remainder of the year.

Capital flowing to the regions

Over the last few years, large flows of international private and sovereign capital have been placed into London. The latest trends suggest this global investment activity is increasingly filtering out of the capital and to the regions.

This has supported restored confidence in the North West, where smaller sized operators are more confident about the future. In Scotland, confidence had dipped (from very solid increases over the past two years) with the independence referendum likely to have had a destabilising effect. Now that the referendum is behind us, I’d expect confidence to surge again, albeit from a lower base.

Beyond large city hubs, there is also new and steady confidence in the secondary market cities across the UK, especially from new investors. Whereas 18 months ago you might only have had one bid for a non-prime asset – be it office or retail – in a secondary location, you might have a dozen parties chasing that asset today.

However, there is still quite a wide gap in the investment interest in London and the major hub cities, and secondary regional cities across the UK. London continues to enjoy incredibly strong occupier and investment activity that continues to be tough to match throughout the UK’s main hub cities.

We believe another factor in the softening of growth in confidence is that many international and sophisticated institutional UK investors are now also looking offshore to Europe and other recovering markets. This has taken some pressure off London and the UK as a clear favoured destination for global capital prime asset flows. Clearly, there are real opportunities in such markets, with increases in activity likely to have an impact on the UK market, at least in the short term.

Seeking out value

As market values have bounced back post-recession, UK yield arbitrage opportunities have narrowed. Over the last few years, fiercer competition has meant yield compression across the UK is such that many participants no longer see the value they once did. In secondary regional markets, the evidence is that we are still some way off the risk pricing indifference we saw in 2007, where subprime regional yields became relatively closely aligned to prime London.

Whereas a year or two ago, it was far easier to find opportunities to create value, mid-market participants are now having to become far more specialised as they search for value. They’re hunting for turn-around opportunities with assets and are specialising further into secondary markets. They are taking more market risk in a sophisticated way. This is an interesting side effect of the latest market trends, and one that could prove significant in terms of the type of activity we might expect going forward.

Find a niche

To compete against the wall of institutional capital that is now entering into all areas of the commercial real estate market, private real estate groups must find and execute transactions that suit their skill set and longer term investment needs. Quick turnaround profitability seems to have left the market for the moment in secondary markets.

For some, this might indeed mean enhancing their regional market knowledge and skill set and looking at how they can identify value and quarantine risk where others cannot. Regional short dated cash flow industrial secondary assets, student accommodation, secondary located residential development and non-prime retail are good examples of where the markets are continuing to provide challenge and opportunity.

Footnotes

1. The CPCM is Lloyds Bank’s countrywide, biannual survey giving a representative, regular view of 500 business leaders’ confidence in the UK commercial property market. They include principals (house builders, developers and investors) and advisors (agents, surveyors and consultants) in small, medium and large property businesses. For more information click here

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