Standard Life Investments Global property update Q2 2010 This information is for institutional investors only and must not be relied on by anyone else. Anne Breen Head of Property Research, Standard Life Investments Global property themes Liquidity still pouring into property A significant volume of liquidity continues to target global real estate. Bank restraint and an amend and extend approach to refinancing has so far resulted in a severe supply/demand imbalance for property assets. We expect this to moderate in the second half of this year with banks working further through their loan books and government asset protection schemes likely to be selling stock in the most competitive markets. That said, the supply is unlikely to tip the balance too much in favour of buyers. Lack of supply is underpinning capital values The lack of supply of stock has underpinned a more rapid bounce in capital values than was widely expected. Some western property markets, such as the UK, have moved to fair value, while some Asian markets now look expensive, for example China. Many of our favoured markets, including France and Australia, still look good value. Limited space is keeping tenants occupied Tenant activity remained more resilient last year than expected, particularly in markets with less exposure to financials, such as Paris. Asian property hubs such as Hong Kong also remain robust. The first quarter of 2010 marked a subtle change in tenant sentiment globally, as there was a wider recognition that the outlook for new space is limited. As rents have bottomed, the opportunity to capitalise on cheap space is narrowing, which has led to a spike in tenant activity in Central London and the upward movement in rents. Lending is slowly letting up Banks, particularly those who were not key lenders between 2005 and 2007, are back and lending again. However, appetite to lend on un-let development remains in the doldrums. Capital markets are a key source of funding, particularly of portfolios and riskier assets. The cycle rolls on Overall, the differentiators of this property cycle remain in place: a slow and gradual economic recovery path, historically low borrowing costs, lack of good quality accommodation, severely limited new stock from 2011, and the increasing dominance of capital markets for finance. Scarcity of stock 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 EU Prime s - Net Additions % of stock 0.05 0.045 0.04 0.035 0.03 0.025 0.02 0.015 0.01 0.005 0 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 Total net additions Net additions as % of stock Forecasted Source: PMA, SLI 0
Markets in detail UK property Recovery moderating but still on track the UK property market recovery continues although strong momentum is moderating. The most recent data from IPD detailed that prices continued to strengthen in the first quarter of this year, although the pace of improvement has slowed moderately compared to the final quarter of 2010. Central London offices are leading the recovery property agents are generally reporting a strong recovery in occupier demand for Central London offices. Several large transactions have taken place earlier than anticipated and there are now only 15 units over 100,000 sq ft available in Central London. The capital s recovery is expected to continue to gain traction for several reasons. Firstly, there is a significantly higher level of lease expiries expected in the next few years, due to the large number of long leases signed in the early 80s and 90s. The constrained development pipeline, which resulted from restricted funding during the credit crunch, will also remain supportive. Institutions overtake overseas buyers large domestic institutions have become the dominant buyers in the UK property market, taking on the mantle from overseas investors who were particularly active last year. UK institutions accounted for 42% of buying activity in the first quarter of 2010 compared to a 27% share of purchasing activity over 2009. Banks more willing to lend - there has been an improvement in the number of banks willing to lend to property and willing to lend in larger quantities. The agent Savills detailed that the thaw in lending to property had improved further and there were now 21 banks, 13 of then from Germany, willing to finance deals in the 30 million bracket. European property Revival in investment markets sharp yield compression in the UK has seen European investors turn their attention to domestic Continental markets. In addition, bank lending for property has eased and club deals for x100 million require fewer investors, increasing from stakes of x25 million to x50 million. These stronger investment trends have resulted in yield compression in selected Continental markets, halting the sharp declines in value. Retail transactions dominate - investment deals have largely taken place in the retail sector. Some of the largest have included Corio s acquisition of a retail portfolio for x1.3 billion, Unibail-Rodamco s acquisition of the Simon Ivanhoe portfolio and MGPA s acquisition of two shopping centres in Poland for x235 million. In the office market, there has been a surge in sale-and-leaseback activity, as banks offload retail branches. These have included Banco Sabadell s x403 million deal with Moor Park and Banco Popular s divestment of surplus assets. Strong absorption of space - take up remains resilient and in the stronger occupier markets like Paris, Stockholm and Warsaw, tenants incentives are reducing. Rents are bottoming and there are tentative signs of rental growth in markets where prospective tenants are recognising the shrinking supply of new space. In Paris, a nine-year firm office lease was signed with a rent-free period of approximately two years to June 2012, followed by a rental rate equivalent to that of the last peak. Subdued construction activity before the recession took hold, construction activity in Europe was muted. Although overall debt markets have thawed and lenders are returning to the market, willingness and risk appetite for development lending have not. As a result, new supply of space from 2011 is set to fall to levels not seen for more than 25 years. UK property yield still attractive Strong office demand in Paris 9 UK property initial yields GDP growth % 6.0 Paris Take-up v Economic Growth Paris office take-up (in million m 2 ) 2.7 8 5.0 2.4 7 4.0 2.1 6 3.0 1.8 5 2.0 1.5 4 1.0 1.2 3-0.9 2-1.0 0.6 1-2.0 0.3 0 Apr 00 Apr 01 Apr 02 Apr 03 Apr 04 Apr 05 Apr 06 Apr 07 Apr 08 Apr 09 Apr 10 IPD initial yields (time weighted) UK (GBP IR SWAP 5 year - middle rate UK benchmark bond 10 year 3M Interbank rates Source: Datastream -3.0-90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Paris office take-up World GDP growth FRF GDP Source: CBRE, Datastream 2
US property Increased activity investment activity in the US is improving, which is leading to better-than-expected pricing. Despite the increase in available product, volume remains muted compared to historical levels. There is a huge volume of capital in the market looking to be placed, which means that any assets that do come to the market are attracting significant attention. New lease of life for certain markets - leasing activity has increased in leading markets, such as New York, as tenants look to lock-in cyclically low rental rates. Reluctance to expand - absorption still remains negative in the majority of US markets and expansion by tenants is still extremely rare. US construction falls % of existing inventory 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 US quarterly Construction levels 1982-85 1986-89 1990-93 1994-97 1998-01 2002-05 2006-09 2010-13 Industrial Source: PPR Asia Pacific property Asian growth remains strong economic growth in the Asia Pacific region maintained strong momentum in the first quarter of 2010. Singapore registered a sharp 13% bounce in first quarter GDP and China is growing steadily at low double-digits. Hong Kong s recovery, meanwhile, has taken hold as retail sales surged 25% year-onyear in quarter one. Australia and Japan s growth was more moderate but the conflicting inflation outlook prompted the authorities to take divergent monetary policy. Central banks action is mixed - the Bank of Japan is mulling over whether to ease monetary policy to promote bank lending and seek an exit from deflation, whereas Australia s central bank is fighting inflation by hiking interest rates by 0.75% so far this year. China also raised banks required reserve ratios three times to sterilise liquidity and issued the most stringent ever policy measures to curb housing speculations. China s currency is widely expected to appreciate soon amid the heavy political pressure from the US and the recent voluntary revaluation of Singapore s currency. Housing in high spirits the housing markets in Asia Pacific are buoyant. Residential prices rose by mid single-digits in places like Hong Kong, China, Australia and Singapore. Japan witnessed a definite turnaround in condominium sales, as the developers reduced prices after taking impairment charges on old inventories. Various governments have implemented policies to prevent the formation of housing bubbles using a combination of: - lower loan-to-value ratios for mortgage, - higher mortgage rates, - restricting purchases by non-locals, - higher levies on luxury properties - and an increase in land supply. market stabilises - virtually all office markets in Asia showed concrete signs of stabilisation. Hong Kong led the pack with a 7.5% increase in central business district office rents during the first quarter. China also experienced moderate office rental growth despite prevailing high-vacancy levels. In Japan, the peak of vacancy rates in central Tokyo is now within reach according to most market forecasts. Leasing incentives offered in Australia have fallen from around 30% to 20-25%. 3
Monitoring property s recovery triggers Below is an overview of the key triggers we monitor that indicate a supportive environment for global property. Property Triggers Trend Change on last quarter Margin over govt bonds Close to record level Declined slightly Margin remains compelling across most markets Economic fundamentals Improving Some improvement Asia accelerating, indebted economies lagging but recovering Flow of capital Improving In-line Capital sources broad based: REITS, Sovereign Wealth, Pension Funds & Retail Investors Derivatives pricing Improving Some improvement Derivatives in the UK are currently pricing in values falling approximately 7% this year compared to 25% decline expected in January REIT pricing Improving Some improvement Sector premiums reflect improved confidence in valuations Fund flows Improving Significant improvement Positive in-flows Quantitative easing/stimulus Continuing Further extension Cautious removal of stimuli likely Lending Weak Weak Strong in Asia but remains weaker in the West Sources: Property Data, Morgan Stanley, Cazenove, IMAS, BofE Key global property market risks The table below highlights some of the potential risks for global property markets. Global Risk Factor Current Risk Monitor Outlook for the Risk Factor Sovereign debt concerns and contagion The global recovery reverses Global stimuli is removed too early, leading to double dip The income yield on property becomes less attractive Increasing risk aversion by global bond market investors over large budget deficits Data suggests global recovery continues to materialise Policymakers unwilling to remove the global stimuli too rapidly Property yields continue to look fair value globally relative to the yield on other assets Increased for Greece, Portugal and Spain but remains low for developed economies Global growth remains on track despite China s slowdown measures Policymakers erring on the side of caution in order to protect the recovery Currently there is a low probability of this risk as policymakers reiterate lower for longer policies Source: Standard Life Investments proprietary knowledge - not traced to single source 4
Property House View changes Q2 2010 UK No change The UK House View is broadly similar to last quarter. We remain most optimistic on Central London s and expect the nascent recovery there to gain most traction in the near-term. We are also optimistic that offices in the South East and dominant Shopping Centres and Fashion Parks provide the next best prospects. Although stockspecific opportunities are likely in secondary assets, we remain pessimistic towards lower-quality assets due to elevated availability and vacancies. Europe German logistics Neutral to Heavy There has been a marked improvement in German exports and greater demand for German logistics, driving rents and yields. We expect yields to start contracting and are forecasting only a small amount of rental decline in the first half of 2010. Czech logistics Sweden offices Finland offices Czech retail US and Canada Heavy to Neutral These countries went into deep recessions and their slower economic recovery is likely to prevent a quick recovery in the property markets. However, property market fundamentals remain attractive and we will closely monitor the situation. LA Downtown office Moved to Neutral The downtown office markets continue to improve New York Midtown Upgraded to Very Heavy in terms of fundamentals bottoming and the outlook improving. There was a sharp contraction in capitalisation rates across all product types as there was a slight increase in deal volume at better prices than anticipated. New York Downtown office Neutral to Light There remain a number of question marks over future development, and several large, known vacancies in the pipeline. New York Malls Moved to Light The US consumer sector continues to lag. San Francisco Malls Moved to Very Light Class A industrial Calgary Class A industrial Toronto Edmonton industrial Class B industrial Montreal Class B industrial Toronto Class B industrial Vancouver Asia Pacific Light to Neutral Heavy to Very Heavy Neutral to Light In Canada, there was a sharp contraction in capitalisation rates across all product types as a result of a significant increase in deal volume at better prices than anticipated. The Class A industrial markets are approaching bottom as demand turns around in the leading markets, while Class B markets are lagging somewhat. Australia Moved to Heavy Supply is tightening and tenant demand increasing on the back of healthy finances, a well-run economy and strong recovery. China Moved closer to Light Concerns on government measures to cool the property market including increased stamp duty. Note: the chart above shows calender quarterly changes to Global Property House View. The markets are ranked against one another in terms of performance in local currency terms, are not risk adjusted and exclude transaction costs. 5
Our Property House View Q2 2010-3-year view UK EU Canada US Asia Very Heavy Grade A City Off Core West End Midtown s Paris CBD s Paris Dec s Poland Retail Belgium Logistics France Retail Vancouver Retail Edmonton Industrial Vancouver Industrial Ottawa Retail New York Midtown Washington Core San Francisco Downtown Sydney s Melbourne s France Logistics Heavy Neutral Light Very Light Grade B City s Other M25 s Regional Shopping Centres <50k sq m Retail Fashion Parks Major City Prime Shops Retail Warehouse Bulky Goods SE Industrial District Shopping Centres <50k sq m Med Town Prime Shops Distribution Warehouses (London) M25 West/M4 s Provincial s Solus RW Secondary/Small Shops Distribution Warehouses (ex London) Provincial Industrial Secondary Shopping Centres German Logistics Belgium Retail Poland s Poland Logistics Belgium s Czech Logistics Sweden s Finland s Czech Retail Sweden Retail Finland Retail Portugal Retail Netherlands s Portugal s German s Spain Logistics Ireland s Hungary Logistics Czech s Ireland Logistics Rome and Milan s Spain Retail Hungary s and Retail Barcelona s Ireland Retail Madrid Dec s Ottawa Industrial Montreal Retail Edmonton Retail Ottawa Downtown Vancouver Downtown Toronto Retail Edmonton Downtown Calgary Retail Montreal Industrial Edmonton Industrial Class B Toronto Industrial Calgary Industrial Montreal Downtown Montreal Industrial Class B Toronto Industrial Class B Vancouver Industrial Class B Vancouver Sub Calgary Industrial Class B Toronto Downtown Toronto Sub Calgary Downtown Calgary Sub Boston Downtown Los Angeles Warehouse Inland Empire Warehouse Chicago Warehouse New Jersey Warehouse Los Angeles Downtown San Francisco Bay Warehouse Boston Mall New York Downturn New York Mall Seattle Downtown Los Angeles Mall San Francisco Mall Hong Kong s China Logistics China Retail Australia Industrial Australia Residential Brisbane s Hong Kong Residential Hong Kong Industrial Hong Kong Retail Singapore Residential Singapore Retail India Residential Shenzhen s Guangzhou s Singapore s China Residential Shanghai & Beijing s Tokyo Residential Delhi s Tokyo s Madrid City s Explanatory note: The House View shows preference rankings of sectors and markets relative to one another within regions. Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC123321) Registered 1 George Street Edinburgh EH2 2LL. The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited. Standard Life Investments may record and monitor telephone calls in the UK to help improve customer service. All companies are authorised and regulated by the Financial Services Authority. 2010 Standard Life Investments www.standardlifeinvestments.com INVPRP_10_014_v5_T 0510