DTZ

18 August, 2010

• UK all-property DTZ Fair Value Index™ scores 38 against the global index score of 62, as UK offers fewer attractive investment opportunities compared to US, Asia Pacific and other European markets
• UK investors should be wary of yield compression and sluggish rental growth
• Retail and industrial sectors offer investors more attractive returns than offices
• Top-ranked London City offices and West End retail are two of just three HOT UK markets as investment opportunities in key UK regional markets dry up

UK all-property Fair Value Index reveals many markets over-priced

The UK all-property DTZ Fair Value Index™ stands at 38 for Q2 2010 (see Table 1). The Index offers investors insight into the relative attractiveness of current pricing in global commercial property markets. An Index score below 50 indicates there are more markets categorised as cold (i.e. unattractive to investors as expected returns are below risk-adjusted required returns) than hot (i.e. attractive to investors as expected returns exceed risk-adjusted required returns). The current index score of 38 reveals that many UK commercial property markets are over-priced and do not offer attractive returns for investors over the next five years – the average investment holding period.

Fewer investment opportunities in UK than this time last year

Although the all-property score of 38 for Q2 2010 represents an improvement from 33 in Q1 2010, UK markets are not as attractive as they were this time last year, when they scored 55 in Q1 2009. The decline in appeal is a result of yield compression driven by investors who took advantage of the rapid re-pricing which occurred during 2009. This, coupled with a renewed focus on new supply coming on stream, means the outlook for the UK market is currently less alluring than last year.

UK markets have a high share of overpriced COLD markets

The global DTZ Fair Value Index™ for Q2 2010 stands at 62, well ahead of the UK score of 38. This highlights the fact that markets in Europe (49), Asia Pacific (67) and the US (89), offer more attractive investor opportunities than the UK, which in large part has already experienced its recovery and has fewer markets with prospects of rental growth than the rapidly growing economies in Asia.

Hans Vrensen, Global Head of Research at DTZ, comments: “We have devised the DTZ Fair Value Index™ to help investors to allocate funds to commercial property, particularly in this highly uncertain market environment. The indices take into account macro-economic factors such as the European sovereign debt crisis. The index quantifies the impact of these trends on the attractiveness of individual markets over a five-year investment period – providing investors with our foresight.”

Retail and industrial sectors offer investors more attractive returns than offices

The UK all-property Index score masks significant differences between sectors, and the warm retail and industrial markets are currently being dragged down by weaker prospects for the office sector. As Table 2 illustrates, the majority of the cold markets within the UK are in the office sector.

Pricing in UK office markets has generally overshot fair value, as shown by the current UK office Fair Value Index score of 25. This score has fallen sharply from its peak of 71 in Q3 2009, when investors were able to take advantage of historically low pricing following sharp falls in capital values in late 2008 and early 2009, before yields came in. This combined with the expectation of minimal rental growth in coming years, particularly in regional office markets outside of London, will limit the returns that investors can expect from this sector.

London City offices and West End retail are ranked in top three UK markets

Despite general overpricing, a limited number of markets are still regarded as hot prospects, with London City offices and London West End retail markets standing out as offering attractive returns. Table 3 provides a list of the current Fair Value classification for the major UK markets.

Tony McGough, Global Head of Forecasting & Strategy Research at DTZ, comments: “The London City office market is expected to experience continued strong rental growth over the medium term, despite the resurgence in development, with its rapid recovery from the economic downturn. This will provide investors with solid capital value growth and consequently attractive returns over the next five years. In contrast, regional office markets have also shown strong capital value recovery over the past year. Combined with limited rental growth, this results in modest future capital value uplifts and consequently makes most UK regional office markets less attractive.”

A mixed picture for retail

The London West End retail market is rated as hot. Prime retail rents did not fall during the recession, and firm retailer demand is expected to result in rental growth of around four per cent per year from 2010 onwards, providing solid returns to investors. Birmingham, on the other hand, is lagging behind the other cities, and rents are still expected to drop by around six per cent this year, before resuming modest growth.