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Commercial property price falls tempered by interest rates and economic growth, says DB

By Kasmira Jefford - Monday, April 24, 2017 15:19

London commercial property prices are unlikely to see a significant downward reversion given the outlook for interest rates and economic growth, according to Deutsche Bank AG.

Research analysts at the investment bank said its predictions it set out in a report July last year, namely that exchange rate moves would cushion any Brexit related reaction to prices to single digits, have been largely upheld.

The IPD Index has recorded a 2.1% fall since June, and some significant acquisitions have taken place in London by Asian based investors taking advantage of favourable exchange rates – with CC Land’s £1.15bn acquisition of the Leadenhall Building topping the list of biggest transactions.

Revisiting its thoughts on the outlook for the market, Deutsche Bank said there are a number of factors at play in influencing the outlook for commercial property prices - economy, unemployment, interest rates, lending appetite, construction levels, age of existing stock and given recent overseas activity even the Chinese current account.

One of the major concerns has been the impact that the significant pipeline of imminent City office completions will have on rents going forward. However Deutsche Bank believes that this risk is offset by the fact that much of its is pre-let and a large degree is replacing space built 30 years ago which is reaching the point of physical obsolescence.

“The significant pipeline of 2017-20 City office completions is well documented, and can be thought of as a dampening force on rents going forward. The precedent of the early 90s would suggest this could be significant – a repeat of the pattern of the late 80s/early 90s barbell – would see rents falling 30%. But we think looking at rents per Sq m/developments history in isolation like this is too simplistic an analytical approach.”

Analysts Paul Heaton and Conor O’Toole add that in contrast with the early 1990s, when base rates peaked at 15% today’s questions revolve more around when rates will revert to a fraction of this level from their current 0.25%, with analysts in DB’s economics research seeing no imminent change as their baseline, while recognising risks are skewed for the next six-12 months.

Meanwhile lending levels are being driven more at the supply level by the ebbs and flows of the banking system and/or capital markets, than monetary policy impacting demand.

“The strong correlation between lending levels and capital values is one we have articulated before and present again below, making sense on an intuitive level (with a relatively fixed capital stock, the more equity or debt capital pointing at it, can only increase prices).”

The research notes concludes: “All told we think there are many variables impacting pricing, with the level of interest rates acting as a form of gravity anchoring where yields should be.

"While downward pressures do exist, past cycles would suggest it is the combination of rates (early 1990s), lending levels (Great Financial Crisis) and Economy (early 1990s/Great Financial Crisis) which drives substantial downward corrections. With lending today limited mainly to mid 60 LTV projects, and the current path of implied interest rates/economic growth projections, it is hard to see a significant downward correction.

"The supply of space in coming years will exacerbate downward pressure, but it is a) well known, b) a significant component pre-let and c) in our view, to a large degree is replacing space built 30 years ago which is reaching the point of physical obsolescence.”

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