Our market

Economic backdrop

There are increasing signs that the UK economy is slowly recovering from a very difficult 2009. Growth was resumed in the two quarters to March 2010 after six consecutive quarters of significant declines, whilst Purchasing Managers' surveys and employment levels have stabilised after several years of economic contraction. London's economy is, typically, more volatile than the rest of the UK and seems to have enjoyed a more rapid rebound from its nadir. Looking forward, major uncertainties surround UK government fiscal policy and its likely approach to rectifying the very substantial public sector borrowing deficit.

Taking their lead from these more positive trends in late 2009, the equity and bond markets responded and posted strong gains for the 2009 calendar year. This favourable dynamic supported commercial property prices and from a low in the summer of 2009 London real estate values have bounced back sharply. A sustained uplift in capital asset pricing depends on further recovery of the underlying economy, stimulating the demand for commercial premises, and the maintenance of low interest rates. Official UK, US and European short-term interest rates are still at historic lows and the timing of their return to a conventional level will have a major influence on investor purchasing decisions.

Occupational markets

This time last year, we argued that London's occupational markets would recover during the second half of 2010. This prediction, in the absence of a double-dip recession, appears to have been broadly accurate. Demand levels have recovered, leading to stronger take-up, reducing vacancy rates and, latterly, rental growth in selected buildings.

West End

Occupational markets remained weak in the first half of our financial year but began to recover during the second half with the take-up of new office space totalling 2.5 million sq ft up 120% on last year. The volume of office space in the market to let peaked in the first quarter and fell throughout the second half, driving West End office vacancy rates down from 6.7% at March 2009 to 6.4% at March 2010. CB Richard Ellis have reported that across the West End prime headline and net effective (adjusted for rent free periods and other incentives) rental values have fallen by 2.9% and 1.4% respectively over the year to 31 March 2010, although in the quarter to 31 March 2010, headline rental values rose by 6.3%.

Viewings by potential tenants are up year on year, and we anticipate that improving economic conditions, and limited new supply coming on stream should help rental values grow throughout the balance of 2010.

The West End retail market (comprising 32% of our West End portfolio by value) has been more resilient than the office sector in 2009 as retail sales in central London have performed well. In the year to 31 March 2010, average monthly retail sales in London were 9.9% higher than the previous year versus a 4.4% increase for the rest of the UK. London continues to attract large numbers of foreign business visitors and tourists, helping to drive sales for our retail and restaurant tenants.

Rental value movements this cycle vs previous cycles

Rental value movements this cycle vs previous cycles

City and Southwark

In stark contrast to the first half, tenant demand for City offices was strong during the second half of last year, particularly from large space users with take-up some 126% higher in the year to 31 March 2010 than the previous year. As a result, vacancy rates, at 9.0% in March 2010, were down for the third consecutive quarter and rental growth has returned for well located, high quality space.

As the financial and business services community recovers further and the supply of available space diminishes, we expect rental growth to broaden and strengthen as this year progresses.

Investment markets

Conditions in London's commercial property investment market have steadily improved since 31 March 2009 as investor interest in real estate has grown, encouraged by low interest rates, early signs of recovery in occupational markets, weak sterling and high levels of liquidity supported by the wider availability of debt finance. Almost all types of potential buyers are now active in central London markets – UK institutions, private investors, international organisations, property companies, private equity funds and sovereign wealth funds. As a result, in the year to 31 March 2010, central London investment market turnover, at £7.5 billion, was 33% up year on year.

Some commentators question whether recent price rises are sustainable given continued economic uncertainty and the increase in supply of assets to buy (encouraged in part by prices increasing). Undoubtedly, there will be some examples of excessive optimism, but with London's rental markets recovering and the market as a whole priced at around fair value, we expect selected further increases although at a lesser rate than recent quarters. With our specialist market knowledge, we remain confident in our ability to unearth new and interesting acquisition opportunities.

Real capital values

Lead indicators – 2009 in review and 2010 outlook

For many years we have used a variety of lead indicators to help shape our view of the direction of our main markets. In spring 2009 we identified some early signs of a potential improvement in central London property capital values. This prompted us to raise new capital from shareholders in order to take advantage of these conditions. We committed 97% of this new capital within six months into a series of interesting opportunities.

The IPD central London capital value index bottomed in June 2009 and has increased ever since. We believe that central London property values are more likely to rise than fall over the next year, although consistent quarterly growth is dependent on firm evidence of higher rental values. Last financial year we predicted a stabilisation and improvement in market rental values in the second half of 2010. We have seen occupational demand increase as described above, and we expect that GPE rental values will grow throughout 2010/11 from their low point in December 2009. Over the last three decades there has been a strong correlation between UK GDP growth and rental value uplifts so, with the economy improving, we anticipate rents should follow, helped by an impending shortage of newly developed space to let.

This outlook is supported by the direction of our lead indicators over the course of the last 12 months. As set out below, most of the indicators have improved, especially those relating to capital values.

Selected lead indicators

Trends in year to
31 March 2010
Property capital values
Equity and bond prices arrow-up
Changes in new lending by major UK and European banks arrow-up
Transaction volumes in central London direct real estate investment markets arrow-up
Direction of pricing on IPD-based derivative contracts arrow-up
Rental values
UK GDP growth arrow-up
London retail sales arrow-up
Business confidence levels in the central London economy arrow-up
UK output from the financial and business services sector arrow-up
UK finance and business services employment statistics arrow-right
“Demand levels have recovered” “Average monthly retail sales in London were up  by 9.9%” “Central London investment market turnover 33% up year on year”