UK property has been a popular asset class for many investors and indeed for many SA investors over the years. Investors bought into apartments for rental and also into commercial property with the promise of excellent returns. With all investments, including property, it’s important to have a clear understanding of how a return is likely to materialise.
We have discussed property returns in the past, but here we discuss recent developments in the UK property market.
A recent report by property experts Jones Lang and LaSalle made the following comments
o Lack of credit has continued to drive risk premiums higher. This is another way of saying with no credit there are no buyers and hence prices of property and other assets have fallen substantially.
o Rental values are likely to fall over the next two years with London offices reporting the greatest decline.
o Their current forecasts indicate that fixed property yields will bottom out in Q3 2009.
o They expect negative total returns of between -7% and -12% in 2009.
With banks being encouraged to resume their “normal” lending, while at the same time having to recapitalise their balance sheets, they find themselves in a difficult position.
In both the listed and unlisted property market, prices have fallen, especially as weak sellers have exited for the safe haven of government bonds and other lower risk investments. With far fewer buyers property yields have increased and some are starting to see value in this asset class.
The report indicates that rising yields (another way of say falling prices) have “wiped a full 35% – 40% off capital values since June 2007. This already exceeds the 27% correction that occurred between October 1989 and 1993.”
They point out that in the 5 years to December 1995 rental values fell by 22%, yes gross incomes actually rose by 18%. So in an environment when rentals were increasing, property values continued to be written down.
This set the scene for the subsequent rise in values far ahead of the steady income returns.
Remember the total return from an asset is a function of
o The income yield; and
o The increase or decrease in the capital value
As indicated on the attached chart, income yields are generally steady. With property, this is a function of the long term rental contracts.
However the total return is influenced by how capital values move above and below the yield received.
The chart depicts rolling 5 year holding periods.
In the early to mid 1990’s the total return was less than the rental yields received. Then, despite rental incomes remaining steady, capital values escalated and investors received a far higher capital growth.
Now, despite positive cash flows, capital values have dropped substantially, delivering total negative returns.
For existing investors with offshore property, the total return decline has been as sharp as that of equity returns. For investors looking for opportunities, property is starting to look attractive. But this is the case with other asset classes and there is a fair possibility that prices continue to decline in 2009.