Hidden threats for investors set to rise during 2012

In the face of global uncertainty, and with senior debt having dried up, the London property market is benefiting from cash injections, particularly from foreign investors.

John Barrett, head of commercial valuation consultancy, commenting on the Cluttons commercial property market outlook Q3 2011, said: "Central London’s unique ability to produce genuine rental increases in the office and retail occupier markets has ensured it retains its attractiveness for both UK and overseas investors. Indeed, the euro zone turmoil and resulting volatility in the financial markets have reinforced the appeal of well let prime and good secondary assets, particularly those with secure bond characteristics.

"Moving forward we expect the disparity between yields on prime ‘safe haven’ stock and those in secondary locations will continue to widen into 2012. This will be driven by prices weakening on poorer quality property with significant occupier risk. And this is where we are raising our concerns."

Specifically, Cluttons points to the challenging business environment which is delivering a cocktail of enticements offered by landlords to attract occupiers – incentives, shorter leases, reduced rents. This increasingly generous bag of incentives is masking true rental values, which will impact on future performance. Now more than ever, investors need to look under the ‘car bonnet of deals’ if they want to see the returns they expect.

Barrett said: "There are examples of regional investments being marketed as rack rented, supported by letting evidence from headline rents set 12 or 18 months ago. Given the condition of occupier markets, more recent transactions might show rental values today at more than 25% below the passing level, after allowing for the potential cocktail of incentives. This lack of like-for-like transactions may mask investment opportunities but also threatens future investment performance. However, within this environment there are most definitely opportunities for investors who have fully unpacked the value of individual assets, hidden threats remain for the unwary investor."

Other conclusions from Cluttons commercial property market outlook Autumn 2011:

Offices
Cluttons expects the office sector to continue outperforming other markets with West End offices delivering the strongest returns. Even taking into account real rental growth, the majority of take-up will be driven by lease events rather than a sharp upturn in business activity which is expected to remain positive but subdued into 2012;

Retail
Cluttons expects the definition of prime will continue to narrow in the retail sector, but yields will remain firm for the best quality stock. The downturn in consumer spending and rising retail vacancy rates will place upward pressure on yields for secondary and tertiary retail. Rents in most locations outside Central London and select prime centres will fall in real terms over the next 24 months;

Industrial
Cluttons expects negative real rental growth in the industrial sector during 2012 and 2013 in all parts of the UK except hotspots around London and some other key growth areas (for example, Aberdeen, buoyed by the oil industry). The continued fall in take-up of both industrial and distribution space since the summer is consistent with the reported contraction in the manufacturing sector.

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