As if we were not aware of it, the past 12 months have conclusively shown the vagaries of the property sector on the quoted stage. The dramatic fall in property company values since September, following nothing more than a couple of broking houses issuing pessimistic views of the future, makes one wonder whether the existence of smaller property companies is justified. And even the larger companies – fewer in number – have been shown to be at best lacklustre, and at worst ailing.
Quality of management, independence of valuations and attractiveness of stock appear to be of little or no relevance when weighed against the huge discounts to NAV that most property companies are having to suffer. How can it be convincingly argued, with interest rates falling and the outlook for the direct property sector resilient, that our share price should be 35% or more below our NAV of 205p and rising.
Though small, a good number of quoted property companies do have a following and they could, or rather should, be encouraged by their institutional shareholders into forging links with these institutions' direct property arms. These companies would be focused, well managed, probably niche players, operating at the sharp end of the market. They would be able, particularly with gearing, to show good returns, certainly when compared to the returns of the ungeared direct property funds and equities in general.
Now is the time to distinguish between those companies that are run-of-the-mill and those that have more to offer. It seems so often that those making the equity investment decisions have little discussion with their counterparts on the direct property side. Surely the indirect property sector would be healthier if there was greater collusion within the institutions. It would surely lead to better performance from the property companies, and, therefore, the institutional shareholder would benefit.
Institutional property stock could be transferred in some way into the invested company or placed under the accredited management of the quoted company.
Isn't it time for the investing institutions to overtly support the companies where they have a meaningful shareholding, by adopting this pro-active approach? Compared to direct property investment, it has all the advantages and very few disadvantages.
Etienne Thoreau, head of property at Société Générale, has a sneaking suspicion that 1999 could be a good year for bankers.
Two main trends will oppose each other in 1999: the historic low interest rate environment and economic slowdown – the combination of these trends will drive the property market.
From a UK perspective, I believe that 1999 will be a reasonably active year, particularly during the first half, as interest rates continue to fall, while property yields stay stable or even rise. Investors' hopes that the economic slowdown in 1999-2000 is less severe than some are forecasting will be balanced by an awareness of the risk of further worldwide financial turmoil.
Interest rates nearly everywhere are at their lowest level. Over the past six months the UK five-year swap rate has fallen by 1.1% from 6.75% to 5.65%. This has enabled investors to acquire better-quality properties, as the gap between average property yields and finance rates widens, and to borrow at a higher loan-to-value and amortise a significant level of debt over the term of the loan. We have not seen such an attractive financing environment since late 1993, but this was shortlived as yields fell dramatically.
With subdued rental growth and fears of a UK recession, yields are unlikely to fall.
The sudden shock we have all experienced over the summer regarding worldwide financial turmoil and redundancies in the financial sector has brought people back to reality and made them realize that if things change, they can change extremely quickly. Economic growth is likely to slow down as a delayed mechanical consequence of the financial crisis between summer 1997 and summer 1998, but the risk of depression is low. Deflation is not depression.
The complete about-turn in market sentiment has relaxed somewhat over the last few weeks, as stock markets have recovered and interest rates have fallen. However, in the back of my mind and probably many others, is whether another dip, more severe and longer standing, could occur in the new year, as many investors seek to offload positions in an improved market.
From a banking perspective, the introduction of the euro will probably be the most important change. How this translates into a higher level of cross-border property investment is uncertain.
On the financing side, however, I predict a good level of activity, as investors take advantage of this arbitrage position. Banks and investors, however, are likely to be cautious on tenant risk and may well steer towards a multi-let building (different tenants and different lease lengths) rather than a single lease to an average-quality – and possibly risky – tenant. Bankers will also be looking at recent retail failures of medium-size companies, such as Craftworld and Essex Furniture, to see whether leases were forfeited and they faced empty units, or the businesses were sold.
Most investors are taking a long-term view, with few seeking a trading-type facility. The common strategy is to sit tight over the coming year or two on a property yielding a significant differential between finance costs, waiting for a possible yield shift in 2001/2002. Rental growth – unless the lease is due for a review within the next 6-9 months – does not seem to be high on investors' agendas.
Risk-conscious borrowers and attractive financing conditions – could this be a banker's dream come true?
Phillip Nelson, chairman of Nelson Bakewell, argues that there is a future for a medium-sized surveying firm not owned by a US conglomerate.
I may make it a new year resolution not to chuckle when people say that globalisation and co-investment are the keys to future success in property consultancy. They are undoubtedly new dimensions to our business, but they are not surveying's equivalent of the 'Third Way'.
Certainly property – like most business sectors – is becoming more global. As a firm, while remaining wholly independent, we have responded to this by becoming the UK representative of ONCOR – an international network of consultants that covers 45 countries. Yet globalisation in itself is not the Holy Grail.
Since the end of the 1980s, there have been countless predictions about the death of the 'medium-sized' surveying firms such as Nelson Bakewell. This spurious focus on headcount rather than quality meant that the property press was filled with theories that in a few years there would only be mega-firms and small 'boutique' advisers. It just hasn't happened, and yet we're getting the same prophecies now with the spin of globalisation and co-investment.
While the globalisation of our business has to be acknowledged, I have reservations about co-investment. One of the prime drivers behind the case for co-investment is that it motivates consultants. But I am not convinced that an adviser who has more to gain – or lose – from a specific situation will perform better.
High-quality property advice is a product of training, experience and market knowledge. A consultant does not become any more expert or experienced because they have a 5% or 10% stake in a project. If anything, it may make them less dispassionate and diminish the objectivity which lies at the core of all good property advice.
However, identifying shortcomings in the business planning of others is not a charter for complacency for the rest of the business. Next year will bring a much tougher market. Investment dealing revenues will be down, and the air of economic uncertainty will continue to deaden activity across the property sector.
Consultants can have only one approach to such a scenario: quality and efficiency. Surveying firms who came out of the last slump stronger, and went on to flourish, did so by becoming better at servicing their clients and more efficient in doing so. New ways of working together with a continuity of experience, have been the basis of our progress over the last decade. While I do not expect the current lull to be anything like as savage as the last slump, it will be a market which requires redoubled effort and ingenuity.
For the vast majority of surveying firms whose core business is the UK market, 1999 will be the 'year of efficiency and independence'. Efficiency will enable you to combat a less favourable market while independence will draw new business from those clients with reservations about the changed business focus of some leading firms of surveyors.
Those people who believe that property values can only continue going up are likely to be disappointed. Those more sane in their approach, however, might be surprised at the likely resilience of the UK and London property market in 1999.
Whatever the stance on a single currency, we are part of a European continental marketplace. The precise effect of remaining outside that market for the initial stages remains to be seen, but will become clearer in the first half of 1999.
In our own portfolio in the West End of London, we have continued to see leasing interest for offices and retail property from American and European tenants, keen to enjoy all that London offers – English language, a convenient time zone for global trading, and professionalism in the service sector.
The fact is that, whatever the size of requirement – and in the West End the unit size is getting smaller, while in the City it is becoming larger – the requirement is for modern, flexible, new space on the most flexible terms possible. Planners and property owners must respond accordingly to satisfy such demand.
London is seen by many as the classy and trendy city to visit and work in, and that has been apparent despite a strong sterling rate. We should make sure that those people seeking to conduct their business in Europe see the property supply in central London in a similar light.
In the West End there is currently a dramatic shortage of new or Grade A office space. Recent figures from Jones Lang Wootton show a vacancy level of 3.7% of overall supply and 0.7% of Grade A space. Indeed, there are no Grade A buildings over 10,000 sq m (107,640 sq ft) available and only four Grade A buildings between 5,000 and 9,999 sq m (53,820-107,629 sq ft).
There was a good take-up of space in 1998 and there appears a strong tenant demand for well-located, modern offices, although I believe there will be a tendency to move towards shorter leases and greater flexibility of services. With the prospect of deflation, prime rents, which are currently in the mid-£50/sq ft area, will drift, over the foreseeable future, between £50 and £60/sq ft.
The City office market will have a fragile 1999. It is inextricably linked to the fortunes, or otherwise, of financial services companies and professional firms. While there will, without doubt, be further consolidation, this may in itself lead to continuing medium- and longer-term requirements for large headquarters buildings which are not always readily available. Clearly there is a threat from Canary Wharf and London Bridge City to name but two alternative locations to the City core.
The retail market in the major retail thoroughfares in the West End reached new peaks during 1998, although rents must soften in 1999, bearing in mind retail trading prospects. Certain streets off the major thoroughfares have become popular locations and this trend may well continue. The retail market in the City has remained strong, although it is very difficult to create additional retail space.
I believe 1999 will be an active year for the property industry although not a dramatic year in terms of growth. Professionals from all sectors will need to be at their most nimble to react to changes, which many of us will not have seen before, in terms of inflation rates, interest rates, growth rates and global perspective.
Robert Laurence, former head of Argent's investment team, is relieved to be at the helm of a cash-rich private company, Resolution Property.
No longer being involved in a listed property company, it is hard to imagine what my friends in the quoted sector have been going through this year. Stocks that were fashionable in 1997 now make cheesecloth shirts look modish – except that cheesecloth shirts are marginally more likely to stage a revival in 1999.
Companies are unable to issue paper to carry out transactions. Management who are incentivised and judged by growth in share prices are miserable. The talented ones are already considering how to extricate themselves and their assets from the quagmire.
This situation could have at least three outcomes:
I think the third option is unlikely for reasons I set out below; the second is possible but not for the smaller-cap companies, where sentiment and lack of liquidity is against them. The longer the gap between NAV and share price remains open, the more likely it is that institutional investors will get fed up and allow private equity to step in.
But even if this doesn't happen, private equity will have good opportunities in 1999. Property with a good future will be available at yields which, with gearing beyond the levels possible for quoted companies, produces an IRR of 15-20% on running income. There will, therefore, be a keen appetite for decent property, yielding 7.5% and more.
This will, of course, depend on gilt yields and, therefore, medium-term debt staying at low levels. Given the pressure on corporate earnings and the negligible risk of inflation, those with floating-rate debt will have a happier 1999 than those who fixed in the last few years.
Interest rate decline will be accelerated by the government's (silly me, I mean The Bank of England's!) desire to move sterling interest rates in line with the euro. Euro rates should remain under downward pressure from the left-leaning German government.
Following the negative impact of the high pound and high interest rates on the economy, the government may believe that voters would trade economic stability for economic sovereignty. Blair and Brown might, therefore, be tempted to call an election before the full five-year term, quickly followed by a referendum and entry into EMU. The Bank of England will be worried that interest rates, which overshot on the way up (to soften us up for EMU?), will overshoot on the way down, so that the economy becomes overheated at the start of the millennium.
Float your borrowings by all means, but a prudently-applied cap should be worn at all times.
I shall make a few property forecasts, in the hope that in January 2000, people will be too drunk to remember 1999 at all. Retail spending will stay depressed, leaving poor prospects for rental growth. Low-yielding, non-reversionary retail property will fall in value until it is caught by the low-gilt yield safety net. The IT threat to all retail property (not just banks, building societies and travel agents) will be more apparent.
Out-of-town retail and office parks with good parking will benefit from the government's aim to restrict parking in future consents.
Office rental growth will be sluggish, particularly in the City, where there will be more lay-offs. But exceptions could be prime Thames Valley and emerging media locations like Clerkenwell and Camden. Yields for decent offices will settle at a level where a post-debt return of 12-15% a year is possible on existing cash flows.
Central London residential will be hit by fall-out from difficulties in the City. Vacancy rates for industrial will increase slightly but yields will continue to fall for well-located large estates.
Alex Watt, head of property at Standard Life Investments,
There is one big bet for the UK property market next year: continental Europe! Whether the return on UK property is 6% or 12% in 1999 (the range between the most bearish and bullish fund managers in the recent IPF Consensus Forecast survey) is academic – continental Europe will be well ahead. The markets of Paris, Madrid and Barcelona look set to enjoy strong rental growth next year. Oh, and lest we forget, Dublin looks set to deliver another strong year after delivering over 40% total return in 1998.
I take the view that major players in the property market, such as ourselves, should be positioning themselves for a more pan-European investment strategy in the years ahead, Around 300 million people now trade in euros and monetary policy has become a one-size-fits-all interest rate; the rule book is being entirely rewritten and, if the dynamics of the European economy are changing, you can bet the property market will change too. That is why Standard Life Investments is developing 3m sq ft on the Continent.
Nonetheless, turning my attention back to the UK for a moment, we are clearly going ex-growth. There will, therefore, be two key factors which will deliver outperformance next year: firstly, income return, that is, the higher yielding the better; and secondly, scope for yield improvement. The biggest unknown – and always the most difficult part of the forecast to get right – is where yields will be in 12 months time. There has been much talk of a yield re-rating on the horizon, since gilt yields are now under 5%, and look set to stay there. In the circumstances, I do not think that this yield gap, which looks set to widen in the short term, is sensible. A re-rating is bound to occur during 1999 but, whether it happens early or late in the year, is difficult to call. For the record, I expect returns to be around the 8% mark for the year and, even if the yield re-rating happens a little sooner, it would be difficult to see UK returns getting into double digits for 1999.
But that is a one-year view and, although we are all pressurised to obtain performance over what are shorter and shorter time horizons, property is of course a longer-term proposition. With this in mind, I see 1999 as a year of opportunity, low returns notwithstanding. Opportunistic buying, repositioning of portfolios and selective development should all be on the cards as we prepare for the next upturn. London – ever the barometer of the market – is pausing for breath at the moment, but is in pretty good shape nonetheless. Yes, rents are unlikely to move ahead in 1999 and yes, vacancy rates will increase, but the supply/demand balance is probably at its healthiest going into a downturn than at any other similar point in the last 30 years. Starting development next year may just be perfect timing, delivering new products to a market on the upturn in 2001. There are also other areas of the market where demand is holding up fairly well. M25 offices, for example, and, of course, devolution-inspired Edinburgh. In short, there are still opportunities around but it takes a little bravery and some solid groundwork to spot them. Stock selection is the key to successful fund management and, from this point of view, sound research is a cornerstone of strategy. This means not just understanding the macro picture, but getting to grips with local markets and understanding your tenants' businesses as well.
If this cycle (both economic and property) is to be shorter and shallower than previous downturns, 1999 should be the year when the brave start new developments, the opportunistic seek out deals in a quiet market and the strategists readjust the shape of their portfolios.
The dynamic will be having lunch in Madrid. Feliz año nuevo!