However, while property prices have fallen by around 17% from their peak last summer, it now appears that the rate of decline is moderating. The most recent monthly Investment Property Databank report shows an average capital decline of -0.7% in May – significantly better than the 3.7% fall recorded in December 2007. This could indicate that we are approaching the bottom of the cycle and some interesting buying opportunities should emerge over the next six to nine months.

Nonetheless, rental growth now appears to be grinding to a halt across all the property sectors, with recent reports showing the slowest rate of growth since early 2004. The slowdown is most noticeable in the office sector, particularly in the City, where job losses are affecting tenant demand and vacancy rates. Central London rents have already started to fall and we expect this decline to continue for several years.

Transaction volumes have also fallen significantly in recent months as nervous investors continue to shy away from commercial property. Any significant purchasing activity remains firmly in the domain of overseas investors, with most UK buyers still holding off for fear of further capital losses. In addition, borrowing has become much more difficult to secure for UK property investors and developers as banks move away from the over-exuberant lending seen in recent years.

In the current environment, we continue to favour the retail sector, although risks remain over consumer spending and rising living costs. With the exception of central London, the office market in the rest of the UK remains reasonably buoyant.

During 2008, we expect yields to move up further, resulting in a 9% fall in values and a total return of -4.0%. We expect yields to stabilise after 2008, producing total returns over the following three years of around 7.2% per annum. While global uncertainties remain, our outlook remains cautious. We believe income and asset management will be the key drivers to UK commercial property performance going forward.

Conclusion
Despite encouraging signs, we are not out of the woods yet. Should the economy experience a bigger downturn than expected, the outlook for property will be less positive. Also, sentiment remains depressed and we will need some sort of catalyst to encourage investors fully back to the market. Evidence that the worst of the credit crisis is over would be the most likely impetus. The big banks owning up to the full extent of their losses from the crisis will be a step in the right direction. This quarter’s reporting season should provide some clarity on this matter.

What is clear is that the era of rising property prices and cheap borrowing is over. Investors will increasingly base their decisions on property fundamentals such as rents, location, supply and demand and development opportunities. The potential risk and returns associated not only with individual properties but also with the countries and markets involved will become increasingly important to investors.

Despite the apparent difficulties presented by a downturn in European commercial property, price corrections will offer professional investors exciting opportunities to add value by identifying and exploiting price anomalies. Although conditions will be turbulent in the coming months, the long-term prospects still compare favourably to other asset classes. 

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*) Robert Matthews is Head of International Property & Strategy at Scottish Widows Investment Partnership (SWIP). As a part of Lloyds TSB Group, Scottish Widows Investment Partnership (SWIP) holds more than 116bn Euros* in funds under management. SWIP invests in a broad range of asset classes. The real estate team is 26 specialists strong, with an average of 15 years of experience in the industry. SWIP currently manages 7.8bn Euros* in direct commercial property assets. (*as of 31 July 2008)