Real Estate Predictions 2012 - New Realities, New Perspectives

INTRODUCTION

By Claire Faulkner and Anthony Duggan

Making constructive predictions in the current market is not easy. The huge uncertainty and overbearing gloominess makes it all too easy to predict the end of the world as we know it. However, the one thing that the past tells us is that however stormy the current conditions, things will improve and more often than not, create significant opportunities.

We cannot, however, ignore the current climate. Commercial property values are likely to fall during 2012 as secondary property is hit again by risk aversion and tenant default. Retail in particular is due to suffer with the March quarter date a likely trigger point for a raft of retail failures. Both lenders and borrowers will see little respite in 2012 with the year likely to see more banks withdrawing from the UK market and others reducing their balance sheets more aggressively than seen so far this cycle.

Away from the short term market dynamics there are other threats to owners and managers of property. The increasing legislation heading towards property fund managers is likely to add costs at a time when fees are already under pressure. The green agenda is becoming more visible with significant implications for those not fully considering the forthcoming energy performance standards. The acceleration of building obsolescence will be a key issue.

However, in some cases we feel the pessimism is overdone and opportunities do exist. The fall in prices will throw up value for those with cash and the nerve to buy. London offices in particular have seen a huge negative shift in the outlook over the last few months with take up expectations and rental growth forecasts heavily downgraded. We believe that this bearishness will create opportunities for purchasers and for developers.

We hope that you find our predictions for the year ahead informative and useful. Please contact us with any questions, comments or predictions of your own to share!

ECONOMIC CONDITIONS IN THE YEAR AHEAD

By Ian Stewart

Anaemic economic growth is the expectation for 2012 but this will provide opportunities for those with cash, nerve and a long term perspective. High quality safe haven assets will continue to be in high demand, especially those which can provide a positive yield.

The UK ends 2011 facing a possibly severe downside shock to export demand and a renewed squeeze on banks and on credit supply. The central view for most forecasters is that the UK will either stagnate or dip into recession in the early part of 2012. The economy is, at best, expected to show anaemic growth in the latter half of 2012 as household spending picks up and the crisis in the Euro Area abates.

Such views are not held with great conviction. Most economists see the risks to their forecasts as lying squarely on the downside. The range of possible outcomes for the UK economy in 2012 is wide. A break-up of the Euro Area would probably spell a deep UK recession – a prospect few economists are currently forecasting but most see as a real possibility. Equally, a dramatic policy response from the European Central Bank could swing market sentiment positively and bolster prospects for the Euro Area and the UK.

As happened in late 2008, market participants are adjusting to the crystallisation of a major downside risk to global growth – a Euro Area sovereign and financial crisis that threatens the Single Currency. As in 2008, the risk is that things will get worse. We would expect market participants to respond in three ways:

Firstly, they are waiting to be convinced that policymakers have the determination and the policies to preserve the Euro Area. Following the failure of Lehman Brothers in September 2008 it took over five months, until March 2009, before the equity market revived, as it sensed that policy easing would save the day. It wasn't until June 2009 that economists joined in and started raising their forecasts for GDP growth. Financial markets are less confident today that European policymakers will do whatever it takes to save the Euro.

Secondly, without a decisive resolution to Europe's debt crisis much of the UK private sector is likely to be stuck in defensive mode. Capital expenditure, M&A and hiring will suffer. Cash preservation and cost control are likely to be the order of the day. For those with cash, nerve and a long term perspective there will be opportunities to take market share and to acquire assets on the cheap. High quality safe haven assets will be in demand, especially those which promise some level of yield.

Thirdly, the market will focus on those things of which it can be reasonably sure. UK inflation should drop like a stone in the first half of 2012 as 2011's VAT rise and soaring commodity price rises fall out of the published numbers. The Bank of England sees CPI inflation falling from around 5% in late 2011 to 1.5% by mid 2013. Lower inflation would provide some support to the hard pressed UK consumer in 2012. Volatility and uncertainty are likely to be here to stay. Coupled with falling inflation, this points to the Bank of England undertaking further Quantitative Easing in an attempt to bolster growth. Monetary policy is likely to remain ultra loose. Without a convincing upturn in growth prospects, and with the Bank of England buying more of them, gilt yields could well head lower in 2012.

The UK's recovery in 2010/11 was far weaker than those of the 1980s and 1990s. This is consistent with international experience which shows that recoveries after banking crises are slow and faltering. What always looked like a slow burn recovery may well turn into renewed recession. As in 2008/09, we think the best guide to whether policymakers have found the right response will come from financial markets. What will be the signal to turn more bullish on growth and risk assets...