Schroders eyes 2008 UK property correction finale

“By the autumn of this year the correction in rental yields could be over,” Mark Callender, head of international property research at Schroders, said in a joint interview with the firm’s head of property distribution, Michael Clarke.
“By then you could be back in an environment where yields are around 5.25-5.5 percent, income is steady, rental growth is running at around two percent, and you are back in territory where property returns are around seven percent, which from most pension funds’ point of view is perfectly respectable,” Callender said.

Benchmark data from Investment Property Databank (IPD) showed commercial property values in Britain fell by 1.6 percent in September 2007 and by a further 1.9 percent in October 2007 after the once red-hot market peaked in the summer.

But Schroders – which manages £10bn in property assets – said the IPD data was underestimating the true size and speed of the reversal.

Schroders recently cut 12-1/2 percent off the redemption value of units in its flagship £2bn UK property fund.

Overshoot, undershoot
Mr Clarke said the UK commercial property bull market had to unwind after generating annual total returns of 18-19 percent in 2004-2006 and pushing rental yields well below borrowing costs.

There was some potential for things to go too far the other way and for yields to climb by as much as 100 basis points, Mr Callender said. But there were also reasons to be positive further ahead because a lot of capital was waiting to enter the market at the right price and occupier demand was still strong.

Just as British pension funds wanted to diversify out of their domestic property market, so too did Norwegian, Dutch, Danish, German, and other European pension funds, Mr Clarke said. And in the European context the UK could not be sidestepped.

“The UK is 25 percent of the European property market, roughly, so it’s not a market that you can ignore if you want a well diversified property portfolio,” Mr Clarke said.

There was also relatively untapped buying interest from sovereign wealth funds and from private equity funds set up to exploit UK property weakness.

“These funds are looking for 15-20 percent returns and they are not going to get them unless there is a correction,” Mr Clarke said, citing the October 2007 launch of London & Stamford.

Topland, one of Europe’s biggest private property investors, also told reporters recently it has a £1bn plus war chest to exploit property market woes.

In addition, UK property fundamentals were supportive. Unlike the last big downturn in the early 1990s, there was no major overhang of excess supply or threat of economic recession and diving tenant demand, Schroders said.
With the exception of London’s financial districts, there were no big concerns about any of the UK’s occupational markets.

Mr Clarke said Schroders wanted to expand its offering of European funds with the launch of Italian and pan-European products.

But he did not rule out better times ahead for its UK funds.

“If the correction is short and sharp next year could be a good year for promoting UK funds.” Mr Clarke said.