Special Report: Property - Prepare for the pick-up

By early this summer, average commercial property prices had fallen by more than 40 per cent from their peak in June 2007, according to the Investment Property Databank (IPD).

Recent data, however, suggest the worst may be over, with evidence of prices stabilising and renewed competition among buyers. This month, the IPD reported that UK commercial property prices rose 0.2 per cent during August, the first monthly rise in more than two years. Could this mark the start of a turning point in the fortunes of commercial property?

To understand why the environment appears to have changed for the better, it is worth revisiting the sell-off of the past two years. The UK commercial property market has essentially undergone a double dip – a cleansing process that has set the stage for potentially strong performance from the asset class.

Just as the market seemed to be recovering - with overseas buyers attracted by a weaker pound - Lehman Brothers collapsed. The resultant turmoil and loss of confidence sent the economy and asset markets into a nosedive. Investors correctly surmised a decline in economic activity – with heavy job losses – would lead to less demand for commercial property from businesses, shop owners and industrialists.

Vacancy rates crept up as occupier demand for space waned. Consequently, tenants became more aggressive in rent negotiations, with concessions being offered when leases came up for renewal or expiry. This led to downward pressure on headline rents. It was these concerns that prompted the second major correction in property values in late 2008, as prices reflected the challenging economic reality.

Unsurprisingly, these price falls revived interest. Seasoned, opportunistic investors emerged early this year in an effort to secure deals at the bottom of the market. Overseas buyers and property moguls such as Nick Leslau were joined by institutional buyers such as Scottish Widows and property companies such as London & Stamford and Chancerygate Group. Occupiers even took advantage of low property prices to buy the buildings they were renting. A good example was Abbey, the banking group owned by Santander, which in April purchased its London headquarters from British Land for £115m.

Tentative bid approaches in the first quarter of 2009 gradually became bolder. By the second quarter, competitive bids were the only way of guaranteeing a purchase. Initially, buyers all chased the prime deals – the best buildings with government income over 10 years. This wish list proved an improbable dream as competition increased, and buyers have recently been prepared to accept lesser tenants and shorter income profiles.

The basic economic rule of supply and demand has led to the beginning of a stabilisation in UK commercial property prices. Open-ended property funds – at the time the largest stock supplier to the market – have seen outflows evaporate, putting an end to property fire sales.