As with the rest of the financial markets, it has been a torrid time for property over the last couple of years.
Property showed a peak-to-trough fall of 44% between June 2007 and June 2009.
On the face of it, this presents a potential buying opportunity for investors. But the big question to answer first is will property continue its downward trajectory or is there an upturn in sight? Well, interestingly, figures suggest the asset class has started to see a turnaround with positive returns over August 2009.
At the end of 2008 and early 2009, there were many distressed sellers and very few buyers. This imbalance between supply and demand was compounded by the unavailability of bank finance for potential purchasers. The net result was those in a position to buy could be highly selective and this effectively drove down prices. It is this situation that has fundamentally reversed over the past few months as distressed sellers have disappeared and buyers have regained some confidence that the world is not about to end. Pricing for prime property is definitely improving.
Perhaps the biggest single change in this sector is that the UK life and pension funds are now back in play. Many of these were previously forced sellers due to redemptions requirements, but they have now found redemptions have either dried up or their cashflows have turned positive. These funds often have substantial cash positions, and not only have they stopped selling properties but many have now become buyers.
As a result, recent demand has outstripped supply, putting upward pressure on pricing and leading to a rise in values over the last two months. From a steady start at the beginning of the year, institutional investors, particularly UK pension funds, have upped their appetite for the sector.
The current demand in the market is focused on secure properties on long leases that offer the protection of upward-only rent reviews or uplifts in line with the retail price index. Such leases are attractive and protect against the potential key risk to the recovery – a fall in the level of rents that tenants are willing to pay.
While rents are still falling, and may well continue to do in the short term, buyers are now drawn to the attraction of income yields of around 7% plus from day one combined with the security of leases lasting 10 years or more.
Property is also proving attractive to overseas funds and to high net worth individuals from around the world. Their perspective is that an income yield of or above 7 % is highly attractive relative to returns on cash of 1% or 2%.
As such, property is now more of a glass half full than half empty. While there are risks around tenant failures and rental declines, buyers, and particularly UK pension funds, believe the potential rewards outweigh these risks.
David Wise is co-head of property, AEGON Asset Management
