UK commercial property values are in freefall

UK commercial property values are in freefall but new ‘vulture’ funds are now being set up to buy in at discounted prices.

The latest data from IPD, the industry yardstick, on Tuesday showed that December was the worst month ever and the last 12 months recorded heavy falls. And if prices appear damaged, then the shares in the listed companies that develop and own property have been savaged as investors have raced ahead of bad news from the valuers of property.

So why are property stocks now being tipped by fund managers and analysts as among the best opportunities in the market?

It may be that the end of the crash is in sight. The slump has been very sharp, and some are hoping that the fundamentals behind property – such as rental income, which is still mainly positive – will begin to support the market.

There is also billions in new money being raised now to buy back into commercial property, both direct and through the shares of heavily discounted property companies. This money could help support the market.

At least two funds are being set up to tap into the beleaguered property market. Sometimes called opportunity funds or vulture funds, these are vehicles that aim to buy cheap property from owners who need to sell quickly. Both are being launched by respected property investment houses that have a long track record of making money for their mostly private investors.

These two new funds are not the only ones looking for bargains in the industry.

Last summer, Invista Real Estate, the property fund manager run by Duncan Owen, announced plans to raise money for a £1bn fund to take advantage of forced sellers in the industry. At the time, many thought that this would be at best a niche fund but now it looks remarkably prescient.

June saw a turning point in the industry as prices peaked and began to tail off. The arrival the next month of the credit crunch exacerbated the problem for the traditionally debt-heavy industry.

According to the IPD index, the last three months have suffered an 8.5 per cent slide in total returns, with December seeing the worst losses on record.

But Owen now says that even if values are falling, shares are “teetering on the verge of recovery”, and warns that you could get knocked down in the rush to pile back into property stocks.

Invista has been joined by Evans Randall and Resolution, the private equity fund managers, in setting up similar funds, while Raymond Mould and Patrick Vaughan, the veteran property entrepreneurs, are to launch an Aim-listed company to pursue the strategy.

Perhaps the most interesting fund launch to date has come from Laxey Partners, traditionally an aggressive active shareholder group.

Laxey said this week that it would launch an Aim-listed investment company that would buy into the devalued shares of companies that own or develop property in Europe.

Such companies are offering what some analysts are quietly describing as an almost unbeatable investment opportunity.

Stalwarts of the FTSE 100 such as British Land and Land Securities are trading at discounts to their net asset value of more than 30 per cent, suggesting that the market is pricing in huge falls in the values of their property portfolios and developments.

On Thursday, Martin Allen, property analyst at Morgan Stanley, changed his outlook on the sector from “cautious” to “attractive”, a statement of quite considerable intent from one of the most bearish property observers.

Allen predicts that property shares will see a “short, sharp counter-trend rally” of at least 20 per cent in the first half of 2008, saying that the Bank of England will be forced to cut UK base rates by around 100 basis points in an attempt to avert a recession.

In particular, Allen changed the buy rating on British Land, Brixton and Segro to “overweight” from “underweight”. However, he warns that in the medium to long-term, UK property shares could approximately halve in value after this rally owing to economic recession.

Harm Meijer, JPMorgan analyst, is just as optimistic. He sees a potential 26 per cent share price growth in the sector this year. “Value is value,” he says. “The downside to the sector is now limited.”

The average discount across the Reit sector was around 30 per cent at the end of last year, and the companies within it offer a range of property investment classes from central London, such as Great Portland Estates, to warehouses, in the case of Brixton and Segro.

As a simple arbitrage investment, the sector holds possibilities, but the big money is expected to be made by picking the property companies that will be taken over.

The last downturn saw a wave of takeovers and “take-privates”. This time around, companies that analysts are talking about include Capital & Regional, a retail fund manager, Mapeley, a property outsourcing company which is in talks to refinance some of its debt, and Minerva, a perennial takeover target that has recently been linked to a number of potential suitors.

Also, the large US Reits have been looking at UK Reits, and these are likely to be joined by sovereign wealth funds. The government of Singapore took a stake of more than 3 per cent in British Land last week.

If the government of Singapore, a canny and long-term holder of property, sees value, retail investors should take note.