Investors and banks are keen to ensure the market holds up

Mar 26 2008 by Dickon Wood for The Journal

Despite gloomy predictions for commercial property values over the coming months, Newcastle-based agent Dickon Wood feels the market still offers opportunities for investors.

THE introduction of Energy Performance Certificates (EPCs) and tougher building regulations will increase the costs of new construction but the resulting fall in supply should mean the value of standing investments will hold up well.

As long as the “real” economy grows by 2% or more, occupiers will continue to seek new accommodation. We anticipate a continued low level of in- vestment transactions in the first half of 2008, with true market prices still generally below current valuation levels. However, valuations are catch- ing up.

Vendors under pressure to sell, such as the retail funds, have adopted strategies to lock investors in, avoiding fire sales, and buyers are only looking for bargains. As 2008 progresses, we expect recovery in transaction levels will be gradual, but slow.

While base rates may continue to fall a little further, banks are likely to remain cautious in their lending policy, demanding large margins and low LTV ratios.

Both investors and banks are in abeyance, keen to ensure that the occupational market continues to hold up before they will renew confidence in commercial property. This is despite the comparative value now available in the market.

Vulture and recovery funds set up to take advantage of better value in the market will become increasingly active, and as a result market values are likely to start to stabilise in the second quarter.

Fundamental to this will be two factors: user demand holding up well and the cost and availability of finance. Interest rates should continue to fall, and we are relying on banks to ease credit liquidity as the year progresses.

The vulture and recovery funds will pay particular attention to quoted companies and REITs, trading at significant discounts to net asset value.

Pricing of companies, indirect vehicles and derivatives require close scrutiny as property indices and valuations still lag the market, and need risk adjustment for the stock in question.

Changes in legislation could add to investors’ woes. An increased void rates burden on investors, and the launch of Energy Performance Certificates, for which neither investors nor the Government seem prepared, could not have been worse timed.

However, such market intervention will inevitably create opportunities, and the polarisation between prime and secondary property created by EPCs will enable some investors to profit through specialist refurbishment.

Overall, we expect greater market equilibrium later in the year, and excepting further major shocks in the financial and occupational markets, a gradual stabilising in values, and recovery in transaction volumes after the second quarter, though still some way short of 2006-07 levels.

I expect investors to remain wary of some property performance data, and its susceptibility to not delivering a “real-time” picture of capital value movement. While valuers continue to lag the market, and until pricing stability is achieved over an extended period, relative performance data loses meaning. Index based pricing on indirect vehicles and property derivatives, has become a difficult art, and risk adjustment imperative, relative to the stock under review. In an investment market under the cosh with trans- action levels significantly down, Government intervention is going to further impact on liquidity.

The increase in the void rates burden in April, together with the interrupted preparation for its legislation requiring Energy Perform- ance Certificates (EPCs), will frustrate sales in the short term.

Buyers will have to get used to the idea of greater irrecoverables on in- dustrial property, and with many in- vestors not having EPCs prepared, there will be a rush to get them done, and a shortage of assessors.

As occupiers adopt “green” policies and snub older, energy consuming buildings, we expect rental growth prospects will increasingly be depend- ent on EPC rating. The implication is a widening in the gap between prime and secondary investment product. This in turn will result in developers and speculators focusing on well located older buildings where a profit can be made by upgrading an EPC rating and thereby making a secondary building acceptable to prime buyers.

Dickon Wood is head of investment at King Sturge in Newcastle.