Is prime property overvalued?

10th February 2012

The group will pay nearly £1000 per square foot, compared to a previous high of £965 set by Swiss jeweller Piaget in 2009. Peter Mace, retail partner at Cushman & Wakefield, is quoted as saying rents may push as high as £1,200 over the next six months.

Prime commercial property continued to grow in the second half of 2011, in spite of the prevailing economic gloom. According to the industry-standard index provider IPD, prime property rose by 0.6% in the final quarter of the year. It counterbalanced substantial weakness in the secondary market to give an overall return of 1.4% for the fourth quarter, or 7.8% for the year as a whole.

But the price paid by Ferragamo will provide oxygen to those who have been murmuring about a bubble in prime London property. In this piece PPR Estates reported an increase in distressed sellers over the past two months: "there had been a rising number of "distressed" sellers in other parts of the country, but London had appeared to be immune as prices continued to rise… (There has now been a) jump in the number of inquiries from both residential and commercial property owners in the capital who need to access the equity in their home quickly."

This is by no means an isolated example. Some institutional property managers are reporting similarly inflated valuations in key areas in Europe: "The weight of money seeking the best assets has driven down capitalization rates, an industry gauge for investment that measures rental income as a proportion of property value." The article goes on to suggest that some buildings in London are now being offered at prices that are ‘detached from the economic reality'.

Ainslie McLennan, property manager at Henderson, says that of the three categories of commercial property – prime, core and secondary – prime now looks highly valued. She says: "The type of property that ticks every box – long tenancies, good location, strong tenants – is looking pretty expensive. ‘Core' property, which may tick most boxes, is expensive in parts. It depends on the type of property that can be sourced. If there are distressed sellers, the price can be much better."

But the economic environment does not support a move into secondary property, where valuations are weak and getting weaker. McLennan says that there are still a lot of problems in that part of the market. The banks are offloading their property portfolios with the aim of improving their balance sheets, creating excess supply; there is weakness in the office market as the public sector is trimmed; and the high street retail sector is absorbing lower consumer spending and a structural move to buying on the Internet. She says that there will come a time when these areas are less pressurised, but many will struggle for some time to come. Her solution has been to focus on those areas of the market that may have a strong tenant or a long lease, but may not be in a perfect location.

Equally, the prime market could sustain its current levels for some time to come. The IPD Index shows that the average yield on prime property is 4.8%. This is around 2.5% higher than the 10-year gilt and as such, is still pricing in a chunky risk premium. At the time of the commercial property boom in 2008, the yield on UK gilts and prime property were approximately in line.

The UK continues to be seen as a ‘safe haven' for foreign buyers. It has shored up its AAA-rating, sterling is low by historic standards and is one-step removed from the Eurozone crisis. Equally, demand in prime property continues to be limited. This piece suggests that there is some £36bn chasing £10bn of commercial investment property for sale in central London: 

Ultimately, the world's wealthy is likely continue to support the prime residential and commercial property markets in London. It is difficult to see any of Facebook's new millionaires uprooting from California, but a few flotations in the M4 corridor may continue to boost demand.


More from Mindful Money:

Is a Housing Crisis on the cards?

House Price Crash: Wisdom of Crowds or Digital Maoism?

Property: Should you invest in student digs?

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