London investment market becomes less attractive

The Index, which measures the attractiveness of likely future returns from specific markets showed that the two markets had moved from hot to warm.

The key London City office market shifted from hot to warm following continued yield compression in Q4, from 5.50% to 5.25% and the gradual weakening of the five-year rental growth outlook following strong uplift in 2010. For the City, this marks the end of a two-year period in which the market has been classified as underpriced.

Between Q3 and Q4, the categories of eight of the 20 markets covered by the Fair Value Index changed. The Edinburgh offices market was one of the only bright spots, being upgraded from cold to warm, the two London office markets shifted from hot to warm and five markets moved from warm to cold.

The main factor which caused markets to be downgraded was an increase in the five-year bond yield, amid increasing fears of the impact of higher inflation and the scope for interest rates to increase sooner than markets had previously expected. The yield rose from 1.6% in Q3 to 2.2% in Q4. This raised the risk-adjusted required return. It thus made the expected returns on commercial property, which were unaltered in most markets, relatively less attractive. The deterioration in the commercial property investment market attractiveness was consequently broad-based, affecting office, retail and industrial property.

“Our outlook for the UK has changed little with limited rental growth meaning more markets are reliant on income return,” Tony McGough, global head of forecasting & strategy research at DTZ said. “Fair value index scores decreased globally in Q4, reflecting a generalised trend towards lower property yields, even as government bond yields increased. The US and Asia Pacific continue to lead the way globally and offer greater prospects for investors, supported by strong economic growth and higher yields, but even here the index fell.”

“The global DTZ Fair Value Indexfor Q4 2010 stands at 53, well ahead of the UK score of 33. Asia Pacific and the US offered the most attractive prospects to investors in Q4 with the European market, like the UK, remaining slightly overvalued.”