Recent market movement: UK property values continued to decline in Q1, though the pace of the correction eased from Q4. There are some signs of growing interest from potential buyers and this has encouraged valuers to moderate the pace of yield adjustment, at least for prime properties. As measured by the Investment Property Databank UK Monthly Index (IPDMI), property values fell by 4.7% in Q1 2008 after falling by 9.7% in Q4 2007. The near term is likely to see further weak returns; conditions remain difficult in credit markets and this continues to weigh heavily on investor sentiment towards UK property and also threatens to spill over into the real economy.  

Retail: Whilst retail sales data have proved surprisingly resilient in recent months, there is little to suggest that a period of weaker retail activity can be avoided. Sales growth is expected to slow as consumers respond to higher interest rates, muted employment and income growth and low household savings. The housing market is showing growing signs of weakness with the credit crunch increasingly acting to put upward pressure on mortgage interest rates and decrease the availability of mortgage finance. Weakness is showing up both in prices and transaction levels and this poses a threat to retail sales, particularly for household goods. 

Offices: With the difficulties in the financial sector proving longer-lived and deeper than most commentators had expected, the outlook for Central London offices, particularly the City, looks increasingly difficult. The City also faces the prospect of considerable new supply and rents in this market look to be coming under pressure. With its broader occupier base and lower dependence on the financial sector, the West End looks better placed to withstand the downturn. Equally, occupier markets outside of Central London look more robust; whilst activity is likely to slow as the economy slows, excess new supply in most markets is not an issue.  

Industrial: Industrial occupier markets continue to see steady conditions. The IPDMI recorded year-on-year rental growth of 1.2% in March for the industrial sector, little changed from the levels of recent years. Availability remains an issue, however, and continues to rise because of strong development levels. Rental growth is likely to remain subdued in the period ahead given the combination of relatively modest occupier demand and high availability and development levels. 

Summary: The UK commercial property market has seen material capital value falls over recent quarters; this is primarily as a result of a sharp reduction in the number of able and willing buyers for UK real estate assets. This in turn has come about due to a combination of higher interest rates, tighter credit conditions, growing risk aversion on the part of investors and lenders and growing uncertainty over the outlook for the economy and occupier markets. We believe that the pricing of UK commercial property is starting to look attractive relative to other major asset classes and relative to its long-run history. Nonetheless the ongoing credit crisis and the expected weakening of occupier markets suggest that further significant valuation write-downs are likely in the near term. Aggregate returns from the market are expected to be negative through the remainder of this year and into next. Thereafter, returns are expected to recover and to be largely driven by the strength of occupier demand and rental growth and we expect total returns from property in aggregate over the five years from mid-2008 to average c6%pa.

Read full Morley report below:

UK Property Market Report - Q2 2008

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