This is a summary of a very well written article by Jon Rickert, Investment Director of GAM, a CHF113 billion asset manager, which gives an excellent account of ‘Opportunities for Real Estate debt Investors’.
It’s a well-documented fact that the UK property market, residential and commercial, is cyclical in nature and understanding where we are in that cycle is an important metric for both real estate equity and debt investors.
So where are we in this current cycle in relation to values and yields?
The good news is according to data from the Investment Property Databank (IPD), current average UK CRE values remain about 20% below the last peak in values in 2007. Obviously certain parts of the UK market, Prime Central London for example, has recovered much faster, is back at 2007 levels and post Brexit is potentially topping out.
Whilst values are lower than the previous peaks, property yields, which is the rental income divided by the value, have tightened back to near pre-crisis levels. In isolation this would be a concern but the more important metric is unlike in 2007, the margin of property yield over government bond yield is 40% above its 20 year average.
In 2007, property yields were running below interest rate yields and owners of commercial property were relying on capital value gains not property rental growth. In today’s long term low interest rate environment, property yields are running higher than interest rate yields which leads to a more sustainable investment model.
Rental growth, a supply and demand related metric, continues to grow modestly.
In conclusion, in the near to medium term, whilst there will be volatility in commercial property values, the expectation is that barring any ‘black swan events’, commercial property values will remain relatively flat.
Whilst this is not the best news for real estate equity investors, this does in the current long term low interest rate environment make for a great environment for real estate debt investors.
