UK commercial property to struggle for 'next seven years'

UK - Legal & General (L&G) has warned that the recovery in the UK commercial property market will languish over the next seven years.

According to L&G, this situation is directly linked to the  government's austerity package and the fact consumers continue to deleverage.

In spite of this, the company said it still sees a number of investment opportunities in the UK property market.

Rob Martin, head of research and strategy at L&G Property, said: "While the pace of market returns is hard to predict as the economy remains weak and banks continue to review their exposure, there are still some rare investment opportunities for investors with the right knowledge and resources."

L&G stressed that the strongest returns would come from identifying key trends correctly and then capitalising on them quickly. These trends include the growing divergence between high and low-quality assets, restructuring debt markets, challenging conditions for retail markets and the appeal of alternative rent review structures.

The UK debt market remains challenging, it said, with banks still reluctant to expose themselves to commercial property.

L&G attributed this to two main factors.

First, an important refinancing is needed in the UK real estate market at the moment, which means banks want to reduce their exposure.

Second, the future introduction of Basel III and its high capital requirements mean lenders will be more reluctant to invest in the asset class over the next seven years.

Nonetheless, in terms of debt, other options have been established recently, with new mezzanine debt funds being launched and some insurance companies ready to provide debt.

Martin also notes that the necessary restructuring in stock and flow of debt is "creating the potential for investors to purchase assets or enter into joint ventures with banks", as well as participate in the market as providers of equity or debt.

The UK commercial property market remains attractive for foreign institutional investors - including pension funds - as they see the country as a safe place to invest, according to L&G. The prospect of a strengthening pound is also attracting foreign investors, it said.

In terms of location, investors have a preference for London.

Martin said: "A recovery economy, albeit gradually, with low levels of new commercial property space being built, points to demand and rental growth focusing on the best-quality assets.

"A number of factors are currently favoring occupier markets in London and the South East. That balance is likely to lead to greater price differentiations and lower returns for lower-quality assets."

He added: "Modern, well-located retail assets are likely to maintain high occupancy levels. But we anticipate that poorer-quality retail stock will experience weak demand and falling rents over the next few years, which is likely to require a pricing correction to restore value."