Regional office yields edge out for the first time in five years

Against a rising tide of negative sentiment towards UK commercial real estate, the latest research from the CB Richard Ellis shows that the average All Property prime equivalent yield remained stable at 4.8% in Q2 2007, and unchanged for a fourth consecutive quarter. There was however some evidence to support projections of an imminent correction in market pricing given the rising yields reported in the regional office markets and the industrial sector – the first witnessed in over 5 years.

A reflection of higher borrowing rates, property now shows a negative yield gap over bonds of -0.6 as of Q2 – a marked contrast to recent years. All Property quarterly rental growth was 2.3% in Q2, a result of the continued improvement in the capital’s office market and above expected upward movements in the prime London High Street shop locations. Annual All Property rental growth now stands at 6.9% - the strongest figure in six years. Rental growth in the industrial sector remained muted.

David Wylie, Associate Director, Research at CB Richard Ellis, said:

“With evidence that the level of capital flowing into UK commercial property has moderated, in line with the shift in long term borrowing costs and compounded by concerns regarding the occupier market, there has been a marked cooling in investor’s enthusiasm and a subsequent softening of investment yields across all property sectors. Only Central London offices, benefiting from a surge in rental growth have bucked the wider trend of stagnating capital values. This change in sentiment is likely to set the scene for the year to come, as the scale of the property’s negative gap with gilts is realised, and investors awaken to more challenging market conditions.

The rebound in yields has certainly raised the downside risks associated with returns in the near term and investors should accept the prospect of much lower returns going forward.”

Key Points from the Q2 2007 Prime Rent & Yield Monitor

• The CB Richard Ellis All Property average prime equivalent yield was stable at 4.8% despite signs of growing investor caution towards the asset class. The benchmark government yield rose to 5.5% during Q2.

• Regional office yields softened between 10 and 20 basis points for the first time in over 5 years in Q2, with only Central London and Scottish office yields remaining unchanged over the quarter.

• Boosted by the upswing in Central London office rents, and in particular double-digit rental growth in the West End, All Office rents rose 4.5% in Q2 and 13.5% annually. Outside the South East, there was very little evidence of rental improvement over the quarter.

• The All Property average prime rental growth was 2.3% in Q2, driving annual rental growth to 6.9% - the highest rate since Q2 2001.

• Industrial yields shifted out 10 basis points for the first time in 5 years, while prime High Street and Retail Warehouse yields were stable at 4.6% and 4.4% respectively.

The CB Richard Ellis Quarterly Rent & Yield Monitor provides an indicator of market direction through the collection of prime open market rents and yields on rack-rented property across shops, retail warehouses, offices and industrials from a sample size of circa 750 locations within the UK commercial property market.

**To provide an improved representation of all retail warehouse rents and yields, CB Richard Ellis have used in-house valuation records across a selection of prime fashion, Open A1 and bulky goods parks dating back to 2000 to compile a new weighted retail warehouse index. Prior to 2000, retail warehouse rents and yields reflect the bulky goods market. As of Q1 2007, yields reported in the CB Richard Ellis Rent & Yield Monitor will be nominal equivalent yields, replacing the previous quoted true equivalent basis.