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Is UK commercial property on course for a 1994-like crash?

by Sarah Miloudi on Aug 03, 2010 at 11:59

The strong recovery in the UK commercial property sector bears a striking resemblance to the mid-1990s market, when valuations rebounded sharply – despite falling rents – only to pull back again in the following year.

Having enjoyed a 12% uplift in bricks and mortar prices over the year so far, investors are now questioning how the sector will perform over the remainder of 2010.

Post-January 1994, quarterly annualised returns plummeted in just 18 months from around 39% to 1%.  The underlying fundamentals suggest that while over the next 12 months the market will not mirror the events of two decades ago exactly, the two scenarios could certainly share a resemblance.

Hopes of rental growth

In early 1994, commercial property yields were already running below long-term corporate bond yields, with momentum in the market driven by a belief that strong rental value growth was not far away, given that a lift in economic output was being experienced at the time.

But over the following year it became evident a rise in rents was being held back by oversupply combined with an increase in base rates. These factors worked together to push up property yields and forced down annual returns from 26% nearer to 5%.

At the end of May 2010 property yields were at a high margin over long-term government bonds and estimated rent increases looked subdued. 

Despite the restricted supply, however, few investors are anticipating a speedy uplift in lease prices, as specialists at Invista Real Estate Management pointed out in their quarterly review of the commercial property market.

The management firm said this is largely due to economic growth being weak.

‘While we are likely to see a repeat of the mid-1990s rental price, it is in the investment market that the outlook in the near term looks a little more favourable,’ Invista said in its latest sector report. 

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