Commercial Property Market Summary

ATIS REAL Weatheralls

The comments below reflect our views as at 31 March 2004 and underlie our approach to the valuation of the portfolio. They reflect conditions up to the valuation date only.

The commentary focuses on the prime commercial property markets where the company has significant holdings.

General

UK commercial property investments have performed well in the year to March 2004. Capital values for ‘All Property’ increased by 5.5% according to IPD (Investment Property Databank), an independent benchmarking agency. Most of the increase has come from yields sharpening as demand from a wide range of investors has far outstripped the available supply.

Institutional funds, in particular, have reviewed their portfolio weightings in favour of increased exposure to property. Many have concluded that it represents a good compromise between the low but predictable performance of gilts and the more volatile but higher potential returns of equities. Recent indications by government ministers that REITS (a new tax efficient investment vehicle) are finally to be introduced in the UK have added further to the weight of demand.

Consequently, differentials between property sectors have narrowed and purchasers have tended to make less allowance for factors that would usually warrant some discount.

City of London offices

Take-up, supply and vacancy levels in the City have all been disappointing (but within market expectations), however, there is a general consensus that we are now at, or near, the low point of the occupational cycle. As interest rates have risen, debt financed purchasers have been replaced by UK funds and others who consider that rents will increase soon. This is reflected in stronger demand for investments with short-term incomes, which offer redevelopment, refurbishment or other asset management opportunities. At the other extreme, long let investments with strong covenants remain popular.

Our valuation of Broadgate has remained broadly the same as at September 2003. It provides a combination of the features referred to above. Much of the current income secured is against financially strong tenants on long-term leases incorporating upward only rent reviews. The capital value of the Estate has therefore been maintained despite the fact that we have reduced our estimated rental values to an average of £37.50 per sq ft.

West End offices

Tenant demand in the West End of London has also remained low since our last valuation. Rents have continued to fall but market sentiment is that this decline has now halted. There has even been competitive bidding amongst tenants for the very limited number of top quality buildings that have been available. There is, however, still a surplus of secondary or average space for which demand is presently limited.

Yields have fallen, especially where purchasers see opportunities to take advantage of rents rising in the near future.

Similarly, properties with immediate redevelopment potential have also been much in demand. Purchasers have had to adopt rent forecasts reflecting record levels within their appraisals.

Retail warehousing

Performance from properties in this sector has been remarkable over recent years and interest from both investors and occupiers has once again grown even stronger. This is based on the continuing and fundamental imbalance between demand and supply.

Many retailers who already trade from out of town units are looking to expand their presence. Others who have previously stayed in ‘high street’ locations, are going ‘out of town’ for the first time. This has resulted in significant rent increases in many areas.

On the supply side, the planning regime has remained very restrictive.

Investors and tenants are therefore competing intensely for a finite stock of an asset that is seen as increasingly valuable. In many cases, investors are projecting rental values in order to justify purchase prices.

With demand from a wide variety of sources, including cash rich funds, low initial and reversionary yields have become common across every category of out of town investment.

The very best prices have tended to be for parks (as opposed to single units), especially those with ‘open A1’ retail planning consent. Less profitable tenants can be replaced with new occupiers. The higher rents achieved can then be applied at rent review to the remaining units. Buildings can be extended and reconfigured, and there are opportunities to generally upgrade and ‘re-brand’.

High street shops

High street spending has remained unaffected by recent interest rate rises or concerns over the sustainability of current prices in the UK housing market. Consumer confidence remains high.

Retailers, however, have experienced mixed fortunes. Profits, from which rent is paid, are under pressure in some cases. Further corporate restructuring seems likely. Elsewhere, demand from the more successful traders, has produced rental growth in many locations, after several years of stagnation.

The very keenest investment yields have been paid where buyers see strong growth prospects. This has produced an inward movement of around 50 basis points, to approximately 4.5% equivalent yield for prime stock. Yields formore secondary properties have improved even more in absolute and relative terms. Here, improvements of 100 basis points or more are not unusual.

Shopping centres

These have also shown large increases in value. The rental growth already referred to has fed through to many centres. For investors, shopping centres combine the appeal of retail with the scope to add value through active estate management. They have the added attraction for funds keen to spend cash, of being large ‘lot’ sizes.

Yields have sharpened by around 100-150 basis points for typical town centre schemes, so that initial yields of close to 6% have become common.

A major centre such as Meadowhall is sold only rarely but is subject to the same considerations.

Department stores

Department store investments have benefited from the positive investor attitude towards retail. They typically offer long leases, low rents from which growth can be expected, strong covenants and underlying redevelopment opportunities.

Foodstores

Many of these characteristics are shared by foodstores. In addition, the restrictive planning environment, and the willingness of tenants to extend leases, all appeal to investors. Yields for prime properties have improved to around 5.25%. Purchasers will have been encouraged by evidence of rents increasing for top quality stores, with several reviews settled well in excess of £20 per sq ft.

In conclusion, there is strong demand for all property types from a range of buyers. This is combined with the beginning of recovery and rental growth in a number of occupational markets.

Yours faithfully

Signature of Graham Spoor BSc (Hons) MBA MRICS, Director – Investment Valuations for and on behalf of ATIS REALWeatheralls Ltd

Graham Spoor BSc (Hons) MBA MRICS
Director – Investment Valuations
for and on behalf of ATIS REALWeatheralls Ltd
Norfolk House
31 St. James’s Square
London SW1Y 4JR

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