UK - Economic forecasters and property market analysts have warned the recovery in UK commercial real estate market could be unsustainable.

The Ernst & Young Item Club has published a report arguing the UK market could be destabilised this year when the government ends its quantitative easing (QE) programme and when refinancing pressures on banks increase.

The 3% rise in capital values during December, as recorded by Investment Property Databank (IPD), is unlikely to be sustained going forward, the organisation said.

The Item Club argued the recent upturn had been driven primarily by market sentiment, with investors deciding the bottom of the market had been reached, and by the flood of extra cash and liquidity brought about by the Bank of England's QE policy.

But with QE likely to come to an end soon, and coupled with the risk to banks of more real estate owners defaulting on their loans, the recent rise in activity is likely to fall away, the report suggested.

The Item Club went further to suggest the recovery could become destabilised because there was little sign of a pickup in market fundamentals. Vacancy rates are forecast to rise and rents expected to continue to fall.

"QE is likely to end this week, and the Bank of England will no longer be buying assets from the private sector, with the likely result being that investors holding a greater proportion of their assets in gilts. Ultimately, this could result in the strong inflows into commercial property fading," said Andrew Goodwin, senior economic adviser to the Ernst & Young ITEM Club.

"Banks have given property companies a significant amount of leeway, but with a large amount of funding due to be refinanced imminently, and a proportion of that in negative equity or requiring a high loan-to-value ratio, a rise in default rates seems certain. This will further damage banks' balance sheets and impair their ability to lend," he continued.

"With occupier demand likely to remain weak across all market segments - as the UK economy stutters out of recession - and the possibility of the banks leniency and support for property companies waning, the most significant risks are all on the downside. It is difficult to see how the level of recent activity can be sustained," added Goodwin.

In a separate report, Bert Gysens, executive director at Morgan Stanley, predicted that by the end of the first quarter of 2010, hardening property yields would push capital values up 14% above their March 2009 low point.
It noted that in previous cycles, real estate values remained broadly flat for a protracted period following similar capital value "bounces".

However, Gysens warned that if values rise "substantially more than expected" there was a significant risk for the market to start falling again.

"The market turned on a sixpence not so long ago; this could happen again when stimulus ends and owners start selling into strength," said Gysens.