Property pick-up remains elusive

During 2010, the property industry had hoped to see a second round of quantitative easing (QE) in the UK, but there was to be no repeat of that asset boosting programme. Further QE cannot be ruled out in 2011 but, for now, the commercial property sector has little hope of a hike in values.

Property performance in 2010 was tough. Property companies may have survived the fastest ever correction in real estate values, but the costs of refinancing have eaten into any positive performance gleaned from a recovering market, and rents remain under pressure.

This was reflected in property share price performances. The EPRA [European Public Real Estate] UK index fell 6 per cent in 2010, underperforming the FTSE All-Share by nearly 10 per cent. So could property return to pack a punch in 2011? Sadly, leading indicators look uninspiring - the benchmark IPD index might have seen commercial property values bounce back nearly 16 per cent since mid-2009, but monthly capital growth is anaemic. The UK derivatives market is currently pricing in a decline to commercial property values of around 3 per cent in 2011 and 2012. And indicators for rental values point towards a rise in high-value central London markets, but declines almost everywhere else.

However, hope returned after US shopping centres giant Simon Property Group indicated that it was prepared to make a cash offer for Capital Shopping Centres. Capital has since successfully deflected that approach and Simon has reluctantly withdrawn from the bidding. But a return to M&A talk in the property sector is certainly welcome.

Indeed, Retail-centric Reit Hammerson has seen its shares rally, and there's also read-across for British Land, Land Securities and London & Stamford - all owners of prime UK shopping centres. It's also good news for Reit specialisation. Last year, Capital Shopping Centres demerged from Capital & Counties. At the time, analysts thought the latter was more likely to receive bid approaches - it owns valuable chunks of the Covent Garden estate, plus a giant residential-led redevelopment of Earl's Court, set to receive planning consent in 2012.

Indeed, Capital & Counties is the favoured pick for central London Reit analysts, who fear occupational market outperformance is already in the share prices of Shaftesbury, Derwent London and Great Portland. However, the valuation gulf between prime and secondary property is growing. Sticking with the high-value property-owning companies, though, could prove defensive if the market takes a turn for the worse.

Accordingly, plenty of real estate bosses have been looking to secondary properties in the medium term and, over the last three months, a lot more secondary property has come to the market at investment yields of 8-9 per cent. "In five years' time, we will look back and say that was dirt cheap," said Helical Bar's chief executive Mike Slade at the latest JPMogran Cazenove property round table.

Hammerson's chief David Atkins has spoken about buying secondary property assets that are otherwise impossible to finance by the banks and repositioning them through careful management. This seems more sensible than overpaying for prime assets. Nomura real estate analyst Mike Prew notes that the weight of foreign investment cash targeting UK prime property is beginning to spill over into good-quality secondary assets. "Shouldn't the Reits be buying more than they build?" is his poser for the coming year.

For those choosing to build, required development returns are 15-20 per cent, meaning City and West End offices are the only game in town as these offer the best chance of rental growth. British Land has the biggest development exposure there, with a £1.5bn programme, but Mr Prew cautions that current City office rents of £50 per sq ft are around 30 per cent lower than 1990's in real terms.

BIG YELLOW GROUP33644019.21.2-3.6
BRITISH LAND5274,66319.04.913.1
DAEJAN HOLDINGS2,7004409.62.7-3.6No IC View
DERWENT LONDON1,5751,5941.418.9
GREAT PORTLAND ESTATES3611,12835.72.124.1
HELICAL BAR28233330.90.7-19.1
LAND SECURITIES GROUP7045,39920.64.01.4
LONDON & STAMFORD PR.13171387.13.45.3
ST MODWEN PROPS.17334715.60.6-17.5
UNITE GROUP2013220.0-30.7

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