British hiatus

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About Conference Chatter Anecdotes, insight, observation and analysis direct from the conference circuit.

The latest IPD/IPF PDIG quarterly briefing held Nov. 3 was all about inflexion points: whether U.K. real state has passed one and the extent to which positive economic momentum will be sustained.

The good news for property investors is that the U.K. economy could be in better shape than the rearview mirror suggests.

The bad news is that the windscreen is misted up, the road is still bumpy and the clutch is unresponsive.

The well-attended IPD/IPF event — held in the offices of City legal firm Herbert Smith LLP — kicked off with a presentation by Ben Broadbent, senior European economist at Goldman Sachs.

Broadbent's central point was that the British economy is not as poor as the official data suggests — hell, it might not even be in recession.

So all those column inches and all that airtime dedicated recently to lambasting Britain as "the sick man of Europe" may have been premature, even though the country is on track to become the last G-7 economy to exit recession.

The problem with Britain's GDP stats, which on Oct. 23 showed a 0.4% decline in the third quarter even as growth turned positive elsewhere, is that the Office of National Statistics has a history of overestimating downturns and underestimating recovery.

It has what a British police officer might call "previous."

According to Broadbent, the ONS "tends to revise upwards and it tends to do so in size around turning points."

He highlighted the 1980-1981 recession when a cumulative GDP decline of 6.5% was subsequently revised to a negative 2.5% and cited business survey data that currently paints a more positive picture of the U.K. economy and that was historically more reliable.

Broadbent's relatively upbeat economic assessment dovetails with property market data that showed capital growth turned positive in the three months to September's end — the first quarterly rise since the second quarter of 2007, which confirms the U.K.'s current leading role in the global property cycle.

Data from the Association of Real Estate Funds on Nov. 3 also showed positive net inflows into Britain's unlisted pooled property funds industry for a second straight quarter.

Having fallen deepest and quickest, it is logical that Britain's real estate market should find a floor first.

Valuations have nonetheless touched base a lot earlier than investors initially feared, going by the changes in property derivative prices seen through the year. From a negative 20% at the start of the year, U.K. All-Property total returns for 2009 — both rental income and capital growth — are now expected to come in only marginally in the red.

West End offices and retail warehouses showed the biggest falls in cap rates in the third quarter but broad improvements were noted across the board, Rebecca Graham of Investment Property Databank said.

"The numbers suggest we have passed inflexion points for all segments," IPD's Graham said.

It's not just capital growth either; the inflexion point in the rental cycle has also been passed, Graham said, citing data that showed a slowdown in the pace of decline in commercial property rents just 17 months into the downturn.

Back in the 1990s, during Britain's last major property recession, it took 46 months before there was any improvement in the rental cycle, she said.

Back then, Britain's commercial property market was also burdened by a long pipeline of excess speculative development that took years to work through. This time around the supply-side is more disciplined.

If things are really getting better, though, why the lingering negativity? Probably because recovery will be private investment-led rather than consumer-led.

Average disposable income is likely to be dented as sales tax relief is reversed, interest rates level off or even creep higher, fuel costs rebound, unemployment continues rising and public sector spending is slashed.

"It's not going to be a feel-good recovery. ... But it's kind of what we need: a little less excitement," Broadbent said.

When asked by this writer whether the recovery in property market confidence to date was premature, Gary Sherwin, head of retail investment at Land Securities Group Plc, replied that global property markets are now more transparent and therefore liable to react more quickly than before.

Investors currently are also starved of income while property yields are attractively priced compared with the so-called risk-free rate. "They've got to put their money somewhere," Sherwin said.

He added that the retail occupier market remained "patchy" even though new entrants to the market and new retail formats meant there was "some substance to that recovery."

Simon Jenkins, part of the U.K. development team at American industrial REIT ProLogis, also painted a mixed picture of the underlying property fundamentals.

He said "the return of the occupier market" has been a big plus for ProLogis' British business of late, leading to some 1.5 million square feet of new lettings. But this has been achieved at a cost — namely shorter leases, longer rent-free periods, improved fit-outs, and so on.

"Occupiers are being pretty keen on the sort of deals they are driving," Jenkins said, while industrial landlords had little choice but to indulge them given the end of tax relief on empty properties — a major gripe for Britain's commercial property industry.

So, this writer asked, would Gordon Brown and Alistair Darling be pleased to hear that their tweaking of Britain's property tax regime was helping the rest of corporate Britain to recover?

"I'd hate to think that I'd said anything to please those two individuals," Jenkins responded, and repeated the industry mantra that scrapping business tax relief on empty commercial properties will scupper the development of real estate stock in the long-run.

In any case, he said the British government still has its work cut out to maintain the economy's positive growth momentum, given a still-tough operating environment.  

Blacks Leisure Group plc, the outdoor clothing company, on Nov. 3 became the latest retail casualty of the British downturn when it announced plans for a company voluntary arrangement.

Jenkins said he expected 2010 would remain tough, not least for retailers if consumer spending started to sag.

The pessimism is more pronounced in the property derivatives market, which is now pricing in U.K. All-Property returns of between 8% and 9% in 2010 and 7% in each of the subsequent three years — hardly the stuff of dreams.

For the growth optimists, including Goldman Sachs' Broadbent who is forecasting GDP growth of 2% in 2010, that could yet prove overly cautious, even though the link between GDP growth and property returns is far from perfect.