The report also says the recovery could easily become destabilised because there is little sign of a pickup in market fundamentals – there were further upward movements in vacancy rates and downward shifts in rents throughout last year and this trend looks set to continue.
Dean Hodcroft, EMEIA head of real estate at Ernst & Young, said: "Welcome though the bounce of activity has been, its sustainability is far from certain. The upturn has largely been based on investors deciding the bottom of the market had been reached and the massive decline in prices over the past couple of years resulting in attractive buying opportunities."
Andrew Goodwin, Senior Economic Advisor to the Ernst & Young ITEM Club, said: "QE has also been a significant boost for the sector, with the Bank of England using this new base money to buy assets from the private sector, thus releasing liquidity and allowing these sellers to buy other commercial property assets.
"However, in the UK, QE is likely to end this week, and the Bank of England will no longer be buying assets from the private sector, with the likely result being that investors holding a greater proportion of their assets in gilts. Ultimately, this could result in the strong inflows into commercial property fading."
On the positive side, ITEM has suggested the weak pound – which has lost around 25% of its value since 2007 – will continue to offer support for some time to come. The UK and London, in particular, will remain an attractive market for foreign investors looking to acquire trophy assets at depressed prices.
Perhaps the biggest thorn in commercial property’s side, as predicted by ITEM, comes from the fragility of the banking sector. Banks remain highly vulnerable to property companies defaulting on their loans, with the combination of rising vacancy rates and falling rental values increasing the chances of default.
Goodwin said: "Banks have given property companies a significant amount of leeway, but with a large amount of funding due to be re-financed imminently, and a proportion of that in negative equity or requiring a high loan-to-value ratio, a rise in default rates seems certain. This will further damage banks’ balance sheets and impair their ability to lend.
"This situation does leave a number of companies vulnerable and at the mercy of the banks, particularly when the time comes to re-finance. Some larger companies might be able to bridge the gap through an equity injection, but otherwise the banks are faced with foreclosing."
Perversely, the state of the banking sector might act as a support to the market through the impact on the development of new property. While developments that were already in progress when the credit crunch hit have largely been unaffected, there has been a sharp slowdown in new builds which will severely impact the supply of available property.
However, this said, occupier demand and a plunge in office rents has been particularly severe in the more internationally exposed cities such as London and Amsterdam, where there is a higher concentration of financial service sector jobs.
Goodwin said: "London’s traditionally strong financial services sector has been hard hit by the recession and it faces further challenges which could undermine occupancy rates. There is the threat of further regulation and a series of tax increases which may potentially damage the competitiveness of the capital and draw business towards other financial centres.
"With occupier demand likely to remain weak across all market segments – as the UK economy stutters out of recession – and the possibility of the banks leniency and support for property companies waning, the most significant risks are all on the downside. It is difficult to see how the level of recent activity can be sustained."
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