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A good time to invest?
The UK property investment market has seen a significant turnaround in its fortunes over the last couple of years, in line with most other sectors of the economy, but is seeing a return of confidence and a hardening of values.
Commercial property investment was one of the first markets to react to the banking difficulties and witnessed a dramatic readjustment in the autumn of 2007. Turnover in the market more than halved from £16.9bn in Q3 2007 to £7.6bn in Q4 and values started their downward path. As commercial property was one of the first markets to fall, will it be one of the first to recover?
Turnover & Yields
The industrial investment market (which is primarily made up of warehouse and logistics premises) followed the same trend, although historically comprises no more than 15% of the total investment market and is not subject to quite such extreme swings.
Lambert Smith Hampton monitor the entire investment market and analyse the yields that are being paid on all transactions across the marketplace. The graph sets out the trend in turnover and yield movements in the warehouse sector since the beginning of 2002 and identifies that whereas turnover in the warehouse market was averaging £1.6bn per quarter at the market’s peak in 2006/2007, it has now dropped to an average of £0.6bn per quarter, which represents a return to 2002 levels.
Importantly, yields peaked at 5.75% in Q1 2007 and are now averaging 8.5%, having reached a ‘high point’ of 8.78% in Q1 2009. Property values are affected as a direct inverse to yield and these movements represent a downward shift of approximately 35% in industrial property values.
Interest Rates
Whilst transactional yields have been rising, interest rates have been falling, making the ownership of property more affordable. Bank base rate is currently 0.5%, although the normal reference point for commercial mortgage interest rates is the five year sterling swap rate, which is currently at about 3.5%. The graph identifies that the ‘reverse yield gap’ has never been as great in the warehouse market.
Mortgage Finance
It is not, however, quite as simple as that. If you wanted to finance a property acquisition with mortgage debt, the banks will add a margin to the five year swap rate of between 2% and 3%, which reduces the yield advantage.
Banks are also now insisting on much lower loan to value (LTV) ratios. At the height of the market an LTV of between 80% and 90% was common, whereas it is now rare to achieve a loan with an LTV in excess of 65%. This means there is a much greater need for equity or ‘real cash’ to be put into the deal of between a third and a half of the purchase price.
What is your Property Worth?
The value of commercial property is primarily affected by the following three factors:-
• Location
• Specification
• Lease Terms
The value of a property as an investment is strongly linked to the ‘quality’ of the income that is being generated by the property. This is driven by the financial strength of the tenant occupier and the length of the lease term.
It is common now for a lease to include tenant’s break options, which reduces the ‘term certain’ of the lease and will affect value. Leases with unexpired terms in excess of ten years will often achieve a premium value.
Is This the Right Time to Buy?
Values have seen a significant adjustment over the last two years and, on the face of it, this presents an ideal opportunity to acquire property at yields that have not been seen for a very long time. This ‘advantage’ is enhanced by the current comparatively low interest rates.
There is renewed optimism in the market at present, which is leading to an increase in turnover and a hardening of values. Is this the beginning of the recovery or just a false dawn? Only time will tell.
The decision to buy relies upon many different factors, ranging from the specifics relating to each property to your own personal circumstances.
For specific advice relating to your own property or for advice on investment opportunities, please contact Jeremy Green in our London office in the first instance.
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