The UK Real Estate Sector - Essay Example

Introduction The UK real e sector typically mirrors the political, legal, social and economic environment of the whole country. The real estate outlook is heavily dependent on the balance of payments status, the foreign currency exchange rate, inflation, the health of other European Union countries, the overall investor confidence in the market and the political leadership. Political stability also supports consumer spending by foreign institutional and private investors. The UK features a wide diversity of property markets which resembled varying modes of market leadership, tenant mixes and quality, governance, capital structures, planning permission, leasing structures and accounting. These market-specific characteristics present reliable indicators regarding the UK economic status. The UK real estate sector forms part of the services sector. The main definition of service sector output pertains to the non-tangible, non-commodity aspects except agriculture, mining, construction and manufacturing. The services sector has four broad classification of services based on the national accounts: Distribution, hotels and catering (DHC); Transport and communications (T&C); Finance, real estate and business services (FRB); and government and other services (GOV) (Julius and Butler, 1998). The services sector has grown faster than the rest of the UK economy from 1970-97. For instance, the average yearly rates of growth for the service and manufacturing sectors were 2.6% and 0.7% respectively. Marketed services have registered yearly growth rates of 3% during the same period. Growth has been tremendous in financial services, business services, real estate activities, education and health services, and communications, particularly in computer software and cellular telephony (Gibson and Barkham, 1999). Boltho (2010) projected that the potential output growth averaged 2.9% a year over the last cycle that chalked up a faster growth compared to the previous cycle (2.4% a year; 1986-1997). The acceleration could be traced to exceptional factors: strong net inflows of migrants, a slight decline in the NAIRU (Non-Accelerating Inflation Rate of Unemployment), capital deepening and a trend towards high value-added sectors including financial services. The growth of the UK real estate property portfolio is also influenced by the level of technology on shopping trends, evolving consumer preferences, and the UK government intervention in project management and transportation. Real estate investment decisions respond to the current and future needs of the core business (Nourse and Roulac, 1993). A real estate company enters projects to generate a positive net present value for shareholders. This company will have the best opportunities for creating shareholder value within their portfolio of property assets. The opportunities come in the form of valuable development options, the exploitation of present market information and the utilisation of a well-developed property expertise. Amidst the need to attain net present value from property activities are some factors that may be deleterious to shareholder interests. These negative factors cover conflicts of interest between retail and property activity, negative reaction by external parties such as shareholders, opinion formers, and analysts and an actual lack of genuine property investment expertise. The costs and benefit aspects of diversification into property activity explain the wide variation in property strategy and structure of this sector. The UK's economic cycle has been volatile compared to the other countries of the European Union, reflecting different economic policies, oil price rises and German unification. The UK economy exhibits different trade patterns, oil, company finance and the housing market. The UK government said a period of stability through low inflation and tight fiscal spending is essential so as to enable a sustainable and durable convergence with the rest of the European Union (BBC News, November 21, 2002). Feng and Wongwachara (2009) examined regime shifts in the real estate market. They considered two classes of regime indicators comprising the statistical or technical and fundamental or the quasi-theoretical indicators. They identified the fundamental indicators affecting the real estate performance as the macroeconomic indicators; housing market indicators; and composite economic indicators. They concluded that the macroeconomic indicators have the biggest impact on the final performance on the UK real estate market. The UK Real Estate Sector in the 1990s In the1990s, the UK economy began to experience spiraling inflation rates from 9% to 11%. The inflation rate was higher than the government projections. As a response, Prime Minister John Major decided not to raise the earnings threshold and he hiked the tax burden by approximately 430 million pounds. He had stipulated multiple incentives to help savings through the TESSA (tax exempt special savings accounts). As part of its implementation of monetary policy, the Bank of England began selling bonds due to the rapid deterioration of finances. The interest rates decreased in October 1990 by 1 % to 14% to stave off any economic slowdown. The electricity industry underwent restructuring prior to privatization. In June 1990, the sales of the real estate sector were depressed. Moreover, as a result of the monetary policy, house prices registered sharp falls in Southern Britain. However bucking this trend were the house prices in Scotland and in some parts of the North that had remained stable. In terms of the Balance of Payments, the UK registered a current account deficit 14.4bn with a visible trade worth 18.6bn. Imports growth reached 3%, while exports managed a respectable 11% growth. Unemployment was prevalent since 2.6 million people were out of work. In 1991, the Maastricht treaty was signed, signifying single currency by 1999. Inflation fell by 4.6% as a result of reduced consumer spending. The UK favored the trend towards the 'Single Market' with the 'harmonisation' of banking and financial services and tax systems. The regular elections of 1992 triggered spending increases on health, public transport and education. The Gross Domestic Product (GDP) declined by 1 %. The combined effect of the recession raised unemployment to 2.87 million; approximately half of that figure was out of work for more than 6 months. The area's small and medium scale businesses shut down at a rate of about 1,200 per week. The government had raised interest rates to 15% at one stage of Black Wednesday in a bid to defend the British against currency speculators. The wide doubts about the stability of the UK economy and the uncertainty of the French referendum on Maastricht sent the pound down to its bottom limit. The prevalence of some unmitigated fears that the sterling would be devalued led to the selling of the and buying of the Deutschmark. It was during the recessionary years of the 1990's, that banking institutions became overexposed and suffered from various factors, such as an overdeveloped property market, increasing tenant defaults, losing property developers who had developed in non-prime locations. At that time, there was extremely tight credit, hence, the smaller independent investors with over-geared balance sheets, unoccupied properties or part completed developments represent a higher risk to their financiers. Since the economy was in the doldrums, there were a lesser number of property buyers. In the residential UK property segment, the effects of the global credit crises were beginning to take its toll resulting in a direct effect on the UK property market, as shown by declining house prices in the UK. Many of the British families and immigrants were unable to secure enough substantial credit to get their family mortgages going. Home foreclosures were also rampant. There have also been noticeable changes in the real estate market, with both a fall in the value and quantum of deals. Hence, there has been a marked increase in incentives for buyers to stimulate demand in order for investors and lenders to recoup cash. The assorted combination of lower interest rates, a more stable economy, a net deficit of available housing and greater availability of funding to solve liquidity issues led some to retain optimism for the economy. With house prices having risen significantly over recent years, most house builders sold large parts of their developments "off-plan" to investors who obtained mortgage financing. However, with lenders not lending and less generous loan criteria due to bad market conditions, many investors my not be able to obtain finance for their investments and may lose out on deposits they have bet on "off-plan" promos at risk. Instability in the debt markets led to the difficulty by investors to refinance borrowings that will result in an increase in forced sellers. This will then trigger sharp price falls. All developers and property owners are facing an increased tax bill from the Government. This will definitely increase costs and may push developers to demolish empty buildings to avoid the tax. The continuing downward trend of price movements in real estate is chipping away the profit margins. Moreover, in the UK real estate industry, there were factors that had a tremendous impact the value of assets, both negatively and positively, such as planning, permission standard and rigour of quality control enforcement, environmental issues requirements on new and some converted property developments. Lim and Zhang (2009) studied the usefulness of derivatives in real estate to facilitate investment transactions. The derivatives enable counterparties to project a view on a specific market, without trading the underlying asset. This is used by the real estate industry that is saddled by high transaction expense, long lags in the lead transaction time and lack of short-selling system. The UK has had a ten-year successful endeavor in developing real estate derivative market. UK Real Estate Market in 2010 Deloitte, Britain's second-biggest professional services group has gained a formidable foothold in the 2 billion commercial property consulting market by buying Drivers Jonas, a commercial property adviser. Drivers Jonas's partners are absorbed into Deloitte's partnership, which will boost their earnings. The partners in Deloitte earned approximately 883,000 last year (Times Online, January 22, 2010). The UK real estate market has grown tremendously beginning the last quarter of 2009. By first quarter of 2010, the luxury residential property in London have risen nearly 14% since March, making the city's luxury real estate market the strongest performer in the industry. With new buyer demand on the rise and given the limited supply of houses, the short-term outlook for luxury residential properties in London is very positive. The impact of the "bonus tax' on bankers will exert a very limited effect on consumption spending. The real estate industry garnered a record sale of 22 properties in the areas encompassing Mayfair, Belgravia, Knightsbridge and Kensington. The current real estate prices in this sector have now risen by 13.8% beginning March 2010. The locations seeing the strongest growth are Chelsea, Kensington and Knightsbridge with 3% growth. The revival of the top end of the London residential market began in 2009. The number of buyers increased by 25% in the whole of 2009 compared to 2008 led by interest from Russia, Europe, Italy, and the Middle East,' according to Liam Bailey (Knight Frank, 2009). The residential housing report revealed that the more expensive 5 million to 10 million and 10 million plus price brackets have caught up with the price growth. The growth of the market initially began in the sub 2.5 million segment in the Spring. During December, the strongest market was the 5 million to 10 million sector registering an impressive 2.6% growth. The prime London market has been the strongest property sector in the UK gaining from substantial inward investment from overseas buyers looking to take advantage of the weak pound and lower overall housing prices. In the second quarter of this year, the revival of the City economy has brought more traditional buyers from the banks, hedge fundsand private equityhouses back into the market. Kensington, Notting Hill and Chelsea, have posted growths of 3% for the second quarter. The year 2010 constitutes a high growth year for the UK real estate industry. The demand from new buyers are 25% higher compared to a year ago and supply hovered around 18% lower over the same period. Both the investors and occupiers are competing hard to discover the best properties available in the market. Furthermore, the limited supply is leading the buyers to go into a very competitive bidding, thus driving prices further. The short-term outlook is basically positive. The longer-term market performance rather depends on the effects of the hung election and next year's emergency budget. The recovery signs are very evident in some sectors of London's commercial property market, pushing rental expectations for offices at the fastest rate in over 2 years. Housing rental followed the growth trend of the luxury housing market. For example, the rental expectations rose dramatically for London offices had moved up above zero for the first time since the fourth quarter of 2007. This is the first time that the Royal Institute of Chartered Surveyors (RICS) has reported an anticipated rise in rents for 2010 and 2011. The RICS is among the world's leading professional body for qualifications and standards in land, property and construction. The positive net balance of 57%, for central London office property was the biggest upward increase on record. Commercial property lettings activity continued to pick up across office and industrial property for the second consecutive quarter, although investment demand has moderated outside the London metropolitan area. The UK housing sector continues to post increasing growth particularly in foreign investors and buyers easily take up available space as they have excess capital. Thus, the general confidence in the outlook for lettings increased gradually. There are important factors that affect the industry such as the changing balance of power between landlords and tenants. Growth in inducements being offered by landlords to secure a letting has moderated across through all regions and sectors. In central London, 45% more surveyors reported a fall in inducements for offices compared to 9% in the fourth quarter of 2009. The latest results suggest that a mild recovery in lettings demand has pushed up rental expectations for London office. The lower value of the pound and a gradual rebalancing of the UK economy towards greater export activity had helped the increase of industrial lettings activity particularly in London and the South. Office lettings activity have picked up modestly across the country. Growth in investment transaction activity continued in the first quarter albeit at a slower pace outside the capital. The stronger the price gains this year the less scope for further rises in 2011 without a rental recovery. The investment recovery is actually reined in by rising borrowing costs in the event of a hung parliament. The consumer demand for the prime central London residential property market had heated up as values are largely sustained by low stock levels and a recent surge in demand from foreign buyers. For example, the Savills prime central London index in 2010 recorded a quarterly increase of 3% in the first three months of this year compared with 4.6% in the last quarter of 2009, recording the prime central London price growth to 16.9%. More foreign buyers have kept their options open. There are speculations on the values of prime property reaching a tipping point where buyers will resist pricing over the current level. The specter of further caps on bonuses, higher taxes and a looming election, are expected to stall the market. A a higher stamp duty band will prevent big falls as it is expected to bring sales forward into the 2010/11 tax year. The consequently higher levels of transactions this year will help work against falls in value. Savills research department believes that the longer term prospects for London property are much more positive and significantly better than other UK regions, provided London maintains its status as a major world city and financial center. International buyers have become more important and account for 60% of the prime central London market, up from the normal 50%. This, combined with the weakness of sterling, has drawn out increased investment demand which is supporting some of the lower tiers of prime, as well as investment markets such as east of City locations, Canary Wharf and Docklands. The prime transaction levels have been slower to recover than other parts of the prime markets. Some analysts believe this is due to the fact that this sector of the market more resilient during the crisis. Following the trend of the rest of prime central London, the prospects for longer term demand in this sector are extremely healthy but is heavily dependent on London's primordial role as a world city. The modest growth in ultra prime values, particularly relative to rebuilding of wealth that has happened over the past year, combined with a favorable exchange rate, presents a buying opportunity for ultra high net worth global buyers. Far Eastern and Russian investors have been on the buying spree for London homes in the city. Higher yields and long term rental and capital growth prospects have been attracting more investors, particularly from the Americas and the South East Asia, particularly if the current dollar/sterling exchange rate remains low. Outside of the central areas, some locations that were slow to pick up value last year have shown strong growth in the first quarter of this year. Putney and Richmond, have recorded a phenomenol sales growth of over 9% in the quarter after a lackluster performance in previous quarters compared with Fulham and Wandsworth. The South West London locations of Fulham, Wandsworth and Barnes, which led the upturn last year, appear to be slowing in line with prime central London. The general price levels were up 3.2% in the first quarter of this year, posting a 4.9% growth in the last three months of 2009. British farm lands also gained positive prospects from interested foreign buyers. The value of equipped farms hiked for the first time since summer 2008, increasing by 2% in the final quarter of 2009 to an average across England of 7,200 per acre. The business environment across the country had reflected very limited amounts of land for sale and pent up demand from farmer, non-farmer and investment buyers. Some of the increase in values is due to smaller farms being marketed. In a sense, the smaller farms have higher values per acre, as the value of the house and buildings boosts the value per acre. Given this present trend, there is a need to implement careful lotting of farms to maximize their overall value in the market. According to the UK Farm Agency, sales transactions in 2009 were lower than in 2008 with 7,800 acres of equipped farms marketed in 37 sales, with an average size of 210 acres. This showed lower activity when compared to last quarter of 2009 when 19,100 acres were marketed, in 62 sales at an average of 308 acres per sale. Bare land values dropped slightly across England, by 2%, to an average of 4,800 per acre, demonstrating a return to values previously seen at the beginning of the year, the research found. The view from our farm agents around England are that values have remained broadly the same so this small drop may be a result of the small number of sales and paucity of land for sale in the quarter,' said Wordsworth. But again transaction volumes were low with 2,600 acres marketed in 2009, less than half the amount in the same quarter in 2008, when 5,700 acres were sold. There were also many fewer sales, 26 compared with 43. Savills' projections is that the value of bare land remains firm at 4,800 per acre across England. It has stayed between 4,800 and 4,900 for the past year and, despite the credit crunch, is about 30% higher than it was at the end of 2007,' said Beedell. The report also highlights regional differences. It says there is a noticeable decline in the number of properties and land areas being brought to market in the southern regions of England, most notably the South East, South West, East Midlands and East of England (Marty and Lawton, 2006). While the number of properties and areas of land in the North West, West Midlands and Yorkshire remain comparable to 2008. The heat is coming out of the prime central London residential property market as values are being largely sustained by low stock levels and foreign buyers, it is claimed. The latest published index shows prices have increased but the pace of growth is slowing. The Savills prime central London index saw a quarterly increase of 3% in the first three months of this year compared with 4.6% in the last quarter of 2009, bringing annual prime central London price growth to 16.9%. Rhys (2006) stated that the service sector led by the communications, finance and business is poised to post a positive growth for the next four years. This sector will drive the economy over the medium term. Goodwin (2009) projected that credit became tight and expensive households suffered massive wealth losses as housing and equity markets crashed. The private sector has registered huge financial surplus. This has been matched by public deficit. Some of the heat has come out of the market and values continue to be sustained largely by low stock levels. Buyers are keeping their options open according to Yolande Barnes of Savills. There is a tipping point where buyers resist the drastic rises in pricing. The caps on bonuses and higher taxes are expected to stall the market and significant rises (Savills, 2009). Savills research department believes that the long-term prospects for London property are positive and better than other UK regions. International buyers have become important and account for 60% of the prime central London market. This trend together with the weak sterling has drawn out increased investment demand that is assisting the lower tiers of prime, investment markets east of City locations, the Canary Wharf and Docklands. Ultra prime transaction levels have generally been slower to recover than other parts of the prime markets. This is due to the fact that this sector of the market was more resilient in the downturn, growing through 2008 (Savills, 2009). Like the rest of prime central London, the prospects for longer term demand in this sector are extremely healthy but entirely dependent on London's pre-eminence as a world city. The favorable exchange ratepresents a buying opportunity for ultra high net worth global buyers. Putney and Richmond, for example, saw exceptional growth of over 9% in the quarter after a lackluster performance in previous quarters compared with Fulham and Wandsworth. The South West London locations of Fulham, Wandsworth and Barnes, mirrored a slower growth. Prices were up 3.2% in the first quarter of this year, following 4.9% growth in the last three months of 2009. For 2010, central London properties that were worth 1.25 million at the beginning of this year have soared in value by at least 2,900 a day. The owners of properties worth 1.25 million have seen a daily increase of 26,500 a day. Morever, those owners with over 1.210 million-plus bracket, the increase in value is pegged at 215,000 a day. An analysis by agents Savills found that the prices of central London properties sold for 1.25 million or more. This constitutes a 50 per cent increase in value. The City bonuses and an influx of wealthy foreign buyers drove up the prices. Prices in the key areas such as Kensington, Chelsea, Belgravia and St John's Wood have gone up by almost a third since the New Year. Savills forecasts that prices in central London will rise by 20 per cent in 2010. The firm identified five London streets where houses were sold for an average of 1.210 million in 2009 and nine addresses where they averaged over 1.25 million (Savills, 2009)/. The top addresses are Upper Phillimore Gardens and Chelsea Square. Demand is coming from a wide range of sources with the Chinese and Indians now vying with western Europeans, British and Russian buyers." Four of the 15 most expensive streets are located within the SW3 postcode and in W8 and NW8. The demand for houses is in the most desirable and central areas of the capital. Kensington and Chelsea had the densest concentration of homes of any local authority area at 28 homes per acre. (Western Mail, March 28, 2009). Works Cited Barnes, Yolanda. (2009). Savill's outlook for the UK Real Estate Market. Market Briefing Volume 1. Boltho, Andrea. "Global Forecast: What Could Go Wrong."Oxford Economics, April 28, 2010. "The UK's five tests." BBC News, November 21, 2002. Business Section. Feng, J. and Wongwachara, A. (2009). Forecasting UK Real Estate Returns: A TVAR Approach. Faculty of Economics and Politics, Cambridge University. Gibson, Virginia and Richard Barkham. (1999), Corporate Real Estate Management in the Retail Sector: A study of the relationship between the management of the corporate real estate and corporate performance. Goodwin, Andrew. "UK Forecast Overview: Can the UK economy rebalance as well as recover". Oxford Economics, April 28, 2010. Julius, DeAnne and John Butler. (1998), "Inflation and growth in a service economy", Bank of England Quarterly Bulletin, Volume 1, p. 35-40. Lim, Joong and Yi Zhang. (2009). A Study on Real Estate Derivatives. Boston: Massachussetts Institute of Technology. Marty, Paul and Stuart Lawton. (2006). European Listed Real Estate Sector Credit Q&A on the UK (and Other European) REITs. London: Moody's. Pricewaterhouse Coopers. Asset Management UK hotels: "Not out of the woods yet," An extract from UK real estate insights, Issue 14, November 2009. Rhys, Herbert. "Can service sector growth be maintained"Oxford Economic Forecasting. September 21, 2006. "Savills UK Projections 2009". Available at URL: ttp://www.savills.co.uk/news.aspxcategory=latest%20news&id=11310&page=0 Spence, Alex and Rebecca O' Connor. "Deloitte expands into commercial property with Drivers Jonas deal", Times Online, January 22, 2010. UK Leads Way as Property Investment Sector Steadies: Focus on Prime Assets in Two-Tier Real Estate Market. Western Mail. May 27, 2009. Page 17. Read More