Richard Stanley of DTZ assesses the state of the commercial property market.

The commercial property market has experienced a tough six months, with this trend expected to continue into 2009. Investment yields have moved out by as much as 2.5% in some sectors, affecting the capital value of property by as much as 25%. Earlier in the year we had envisaged the Bank of England following the Federal Bank and dropping interest rates further in an attempt to reinvigorate the economy. However, current inflationary pressures make this unlikely in the short term and any suggestion of market sentiment improving in the present environment appears purely speculative.

Unfortunately the market is in stagflation, with few investment deals surviving the banks' credit committees. Deal volume was in excess of £22bn in the fourth quarter of 2006 compared to under £3bn in the same period the following year. With few comparables available to value property assets, has the market truly re-priced?

Developer difficulties

From a development perspective the market slowdown could not have come at a worse time. Developers have been dealt a cruel double whammy, with waning market sentiment squeezing margins and tender prices for construction work expected to rise much faster than inflation (and little if any capital growth inflation in the short term).

The effect of this is most visible in the regions, where we have seen evidence of sales and capital values collapsing – in some cases by as much as 30% – on certain apartment schemes. Developers are now offering investors incentives to allow securitised ownership of schemes, funded, as always, on the back of ever-hopeful rental demand.

With minimal capital growth and rising development costs, developers may be looking for increased funding from banks. The reality is that plummeting loan-tovalue ratios and general market illiquidity mean this option has almost certainly been extinguished.

Winners and losers

So who will be the winners and losers in these troubled times?

The winners, as always, will be those who plan well, hold good credit history and are able to control their build costs in a stressed market. The failures will be those who do not – and it must be broadly recognised that lenders share ownership of this problem.

Challenges ahead

We have often advised in situations where lending has been structured on fixed cost and forecast capital growth. The challenge now will be to advise banks on their options where poor cost control and stagnating capital values mean lack of appetite for further funding. This is set against a backdrop of minimal values for part-built schemes and the potential for substantial write-offs.

DTZ is a global property service provider with over 12,000 people operating out of 45 countries worldwide.

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