Pictured above: James Bladon

UK property markets now offer less attractive returns relatively to investors than they did, with the latest UK all-property DTZ Fair Value Index™ standing at 33 for Q4 compared to 48 in Q3 2010. The index, which offers investors insight into the relative attractiveness of current pricing in UK commercial property markets, reveals that investment prospects have weakened and that the UK currently has limited pockets of attractive investment opportunities. Manchester offers the best value to investors. Both the Manchester industrial and retail markets are classified as HOT, with solid income return and strong rental growth expected to support values, whilst the Manchester office market is WARM.

Between Q3 and Q4, the categories of eight of the 20 markets covered by the Fair Value Index changed. The Edinburgh offices market was upgraded from COLD to WARM, the two London office markets shifted from HOT to WARM and five markets moved from WARM to COLD. 

The main factor which caused markets to be downgraded was an increase in the five-year bond yield, amid increasing fears of the impact of higher inflation and the scope for interest rates to increase sooner than markets had previously expected. The yield rose from 1.6% in Q3 to 2.2% in Q4. This raised the risk-adjusted required return. It thus made the expected returns on commercial property, which were unaltered in most markets, relatively less attractive. The deterioration in the commercial property investment market attractiveness was consequently broad-based, affecting office, retail and industrial property.

The key London City office market shifted from HOT to WARM following continued yield compression in Q4, from 5.50% to 5.25% and the gradual weakening of the five-year rental growth outlook following strong uplift in 2010. For the City, this marks the end of a two-year period in which the market has been classified as underpriced. There is still strong rental growth forecast, but the market is now ranked as WARM, for example, it is at Fair Value for the growth expected. Outside of London, four office markets were classified as WARM, while five were classified as COLD.  In most of these markets capital values are forecast to show little change over the next five years as modest rental growth offsets rises in yields.

Tony McGough, Global Head of Forecasting & Strategy Research at DTZ said: "Market attractiveness weakened almost across the board due to an increase in the five-year bond yield, used to benchmark property returns. Our outlook for the UK has changed little with limited rental growth meaning more markets are reliant on income return. Fair value index scores decreased globally in Q4, reflecting a generalised trend towards lower property yields, even as government bond yields increased. The US and Asia Pacific continue to lead the way globally and offer greater prospects for investors, supported by strong economic growth and higher yields, but even here the index fell."

James Bladon, Associate Director in investment at DTZ in Birmingham commented: "In the west midlands, the Birmingham office and industrial markets are assessed to be WARM, being appropriately priced and offering investors the prospects of good future performance. DTZ Research forecasts that Birmingham offices will generate an average total return of 7% per annum over the period 2011-2015 and Birmingham industrial a total return of 8% per annum.

"As always, however, stock selection will be critical in the future performance, given that it is still possible to do poor deals in a HOT market and good deals in a COLD market. DTZ recently advised on the sale of One Victoria Square, an office building in a prominent position in Birmingham city centre that offers a number of asset management opportunities. The property attracted interest from a number of investors, before being sold for £17.5m in December 2010. In contrast, several secondary Birmingham office properties in less central locations have not attracted much interest with investors being concerned about their future performance."

The global DTZ Fair Value Index™ for Q4 2010 stands at 53, well ahead of the UK score of 33. Asia Pacific and the US offered the most attractive prospects to investors in Q4 with the European market, like the UK, remaining slightly overvalued.

Martin Davis, Head of UK Research at DTZ added: "London offices remain fairly priced with strong rental growth expected, despite City offices ending its two-year run as a HOT market. Outside London and Manchester, the environment is more difficult to see very attractive opportunities, though in Edinburgh expectations are improving."