3rd May 2007

Hacienda Horrors

Whilst the Spanish property market is very different from our own, there certainly are areas of similarity where over-development has led to areas of oversupply and falling prices. Although this seems to go against the weekly property valuation reports, mostly of course from those companies with a certain interest in it, there are some glaring examples around the UK where “buy to let” overdevelopment has led to local bubbles bursting. If our rates are to increase at the next Bank of England meeting (on May 10th) by 0.25% or even 0.5% then the pressure on these weaker areas will only increase. Does this mean that we will see a “sub-prime” problem as illustrated in the USA? The answer is probably no, as hopefully the apparently improved banking risk controls should have avoided the worse excesses, but there will still be a weakened financial group that will suffer greater pain and this group can only get larger.

In terms of commercial property, there has also been a change. Over the last five years, the IPD UK Monthly Index for commercial property has shown impressive annualised returns of 15.5%. This can be broken down as 6.4% from rental income, 1.5% due to capital growth arising from growing rental income and an extraordinary 7.8% due to capital growth from the fall of property yields as the asset class was revalued.

At the end of 2002, UK commercial property provided a yield of 7%. As financing costs at the time (as measured by the five year money market swap rate) were around 4.4%, property offered investors an attractive investment proposition. This was drawn from a substantial pick-up in income prospects as well as the potential for capital growth from rising rents. However, now things have changed with commercial property yields dropping to 4.5% whilst the equivalent costs have risen to around 5.7% - now that income pick-up has disappeared. Furthermore the ‘crane count’ in the City seems to be rising still, so despite apparent current buoyant demand, supply may well be soon on hand.

This makes UK commercial property considerably less attractive, but more importantly it means that the highly leveraged property deals that we have seen over the past four or five years may now be far less attractive to complete.

Increasingly eyes have been straining to find other areas of property opportunity and Asia would now seem to be the flavour of the month, with even the Duke of Westminster Grosvenor Estate looking to increase their Asia/Pacific holdings from 7.5% up to some 20%.

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And finally……….a poor choice of career I think for the Californian burglar who was captured recently by the police. His attempt at a dramatic escape was somewhat curtailed when his prosthetic leg fell off.

Have a good week,