by Norman Bowie
We are beginning to hear from the Government about the challenges we in the UK can expect when the EEC becomes a single market in 1992. There will be many opportunities for us to do business within what will be the world’s most populous trading area. The early 1990s will also see major changes in some of the fundamentals of the UK property market which will affect our perception of values and their possible trends.
John Plender’s challenging address in 1981 entitled The Dangerous Decade was questioned by many at the time, but his warnings proved timely. The relative poor performance of property against equities, and in some years with fixed interest stock, has been a feature of the investment scene. Only the share market crash of last October put property at the top in 1987, although the underlying trend had for some time been of improving values underpinned by firm rental growth in all sectors. This growth reflected the expanding UK economy, the growing work force, and the rise in credit and spending.
As always, the property industry has responded to this scene of space take-up — with its sustained demand for modern designs and amenities — by bringing out an increasing number of new development schemes. The feast and famine property cycle is here for all of us to watch, examine and take advantage of. In many areas rising rents have now reached economic reproduction levels. The short-term entrepreneurs are using these high rates of growth, as rents climb up out of their troughs, to entice the long-term investor to buy their finished products at lower yields in expectation of further growth at the same rate. Bank lending to the property sector reaches new heights and developers’ profit margins are squeezed.
The rents of leases granted in the last few years will be due for review in the early 1990s, perhaps around the time when the new feast of space will be making itself felt in the market. Some fundamental changes could well coincide with these reviews. Investors need to take heed of these when making their investment selections now and the prices they are prepared to pay for the expected future growth in rents. Low-start yields imply a consistent upward trend in rents and any disappointment at an early stage is really damaging.
In 1990 the non-domestic rate will be introduced — unless the Government has a most unexpected change of mind. It is now clear that in many areas the rates payable by the tenant/occupier will be substantially higher than at present. The City of London looks set for an increase of 50% or above, and in many High Streets traders will pay double or even more. Occupiers are concerned with the total cost of occupation and if one element goes up the only ones that can make a compensating downwards movement are the rent and profits. So it could be that the new rent set at the next review will be below that projected in the purchasing yields. We can expect the arguments to start soon as both new and sitting tenants begin to realise that they will be facing bigger bills from 1990 onwards. At least it will be good business for the rent review specialists. The converse will apply in other areas — many of which are outside the South East and where there could be some case for higher rent increases because of lower rates, particularly if demand is, at least, in balance with supply.
Employers face another harsh fact. There will be a major fall in school leavers. The present group aged 16 to 19 will decline by around 1m during the early 1990s. This means a parallel fall in the numbers of graduates. It represents a challenge and already some employers are taking the matter seriously. So if, say, there is to be an overall increase in London of 10m sq ft of office space — excluding Canary Wharf — from where will come the additional workers to fill the space? No doubt part-timers will increase in numbers, and more married women will restart their careers, so this will give some offset. It could mean that tenants will just move from older buildings to new space, which has all the latest amenities, and leave empty space behind them for which there will be little demand. In that event rents could come off the boil and the older buildings feel the pinch with losses in value. Many provincial cities and towns will be affected in a similar manner.
There are a growing number of new town-centre shopping schemes coming forward. This increase in retail floor space is accompanied by the challenge from large numbers of retail warehouses and superstores to be built on the edge of towns as well as out-of-town shopping centres. Many new projects will have the added draw of a wide range of on-site leisure activities. The shifting age-profile over the years will be reflected in changing spending habits as to the types of goods and services purchased, while the proportions will also change. Some age groups spend more on health or education or leisure. Others save more or spend more on durables than consumables. So these age bulges and dips cannot be ignored. Demographics is a study on its own and where the age groups may wish to locate to live and work is another one. The teenagers are expected to be down by a quarter from their present levels by the mid-1990s and those in their early 20s will be fewer as well. These declines will have some impact somewhere and somehow on the property market.
One population will be increasing without any doubt, and that is the car. Its numbers are growing fast and we all continue to suffer from more and more congestion and frustration. Accessibility to places of work, shopping and leisure and availability of car parking will have an increasing effect on the levels of values and their trends. Except in the larger cities, public transport is not a complete substitute. Employers, who can provide one parking space per employee, will be at an advantage, and their landlords will be able to charge a premium rent.
Road capacity has often been under-provided for by short-sighted transport planners — the M25 and the Dartford Tunnel are outstanding current examples. The economic cost to users held up in traffic jams must be far in excess of the cost of the additional facilities if they had by now been put in place. The Channel Tunnel will be open by 1993 — five years’ time — but we await to see final plans for completion by that date of the essential road and rail links of adequate capacity with terminals to enable the UK to gain the best possible benefit. This outstanding infrastructure project will have a major impact on property values during the 1990s — somewhat similar to that of Heathrow on the Thames Valley, but more immediate.
In the run-up to the 1987 General Election any idea of expansion of housing in the South East seemed to be virtually ruled out. Now we learn of the need, before 2000 AD, for over 460,000 new houses, perhaps as many as 600,000, and that land will be definitely rezoned by government to meet the demand. Some of the demand arises from the natural increase in household numbers but the bulk is owing to migration and the economic pull of the South East. There is a strong argument for the need to increase the supply of dwellings to eliminate house price inflation. This would reduce land values and avoid locking up vast sums of money which produce no reward to the nation and could be invested more remuneratively in the infrastructure and industry — perhaps even in the Hotol project.
Recent economic growth reflects the long-term shift of industrial activity away from the northern half of the country with the decline of heavy industries and the introduction of automation and robotics. This decline has been counterbalanced by the vast growth of the service industries, and although largely based in the South this also reflects the pull and the importance of the closeness of the large market across the Channel. The single market of the EEC is likely to see the fulfilment of the concept of the European Golden Triangle with the western angle resting in the South East of England, the eastern arm in Belgium/the Netherlands and the apex pointing down through North East France, Belgium and North West Germany. Will Frankfurt challenge London as the financial centre of Europe?
So the property adviser and investor have much to ponder on these important fundamentals with their effects on land values and with likely gains and losses. Apart from these problems, buildings are likely to become obsolete rapidly — partly owing to location but also to outdated design and amenities. The effects of the electronic revolution and vast changes in telecommunications and the need for modern facilities are often underestimated in building design and location, particularly for offices and industrial properties. Just as the buildings of the 1960s are now worn out, the decade of the 1990s will show those of the 1970s to be equally tired.
They will be interesting and fascinating days ahead. The investor and his adviser need to recognise these changes in the fundamentals and do their best to arrive at the correct judgment as to where sustained real growth will appear. Stock selection will be the name of the game — freehold ownership and flexible leasing terms will be advantageous in what is likely to be a challenging investment scene.