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Property demand rises but values start to fall

Property demand in the automotive sector is on the rise after a reversal in 2006. Construction orders have reached the highest level since 1999 at a value of just under £1.2bn, according to the latest property index from GVA Grimley.

However, the commercial property market has been overvalued for some time, leading to a price correction towards the end of last year. The recent turmoil in the financial markets has also had a significant impact on UK property investment.

This has been reflected in prime automotive yields which have moved from 4.95% in June to 5.75% in December, with a corresponding fall in returns.

Automotive yields’ up-ward move is based on just a few deals and the market is still potentially over-valued. It is possible that there will be further adjustments in prime yields in 2008 although the shift will be more marginal.

GVA Grimley has downgraded its forecasts for all commercial property and expects the automotive sector to follow suit.

As an illustration of the market’s volatility, all-property total returns in 2005 and 2006 averaged 18.5% per year, while 2007 and 2008 are forecast to total returns at -4.5% pa. The market should revert to more normal returns from 2009 and over the three-year period from 2009 to 2011, all-property total returns should average around 9.6% pa.

However, markets are rarely rational in the short term and sentiment is a major factor in the current market, particularly with the fall-out from the recent ‘global’ credit crunch still occurring.

Therefore the risk is that capital value growth and returns will be weaker than forecast. As a consequence of this change in market conditions, GVA Grimley expects to see some attractively-priced automotive investment properties coming to market in 2008.

Certain opportunities will offer modern, well located facilities, let on long term leases to strong manufacturer/dealer covenants, with good rental growth prospects by comparison to other sectors.

Last year saw a good level of demand for automotive property at 764,000 sq ft. This is significantly above the average annual take-up of 657,000 sq ft since 2000.

Take-up has shown a cyclical pattern, with an increase in 2003 after the review of Block Exemption, followed by a decline in 2004/2005, while 2006 showed the most activity.

Average rental growth dropped 1% in the second half of 2007, with 10 of the 14 cities assessed showing static rents.

Land values for automotive property have continued to rise over the past year, particularly in London and the south east, which have outstripped the other regions in terms of value at £2.5m per acre and £1.5m per acre respectively. However, there has been no growth in these areas over the past six months.

Of the other regions, the west and Scotland have shown the biggest increases in value over the past year, says GVA Grimley. West Midlands, north west and Merseyside, Yorkshire and the Humber and Wales have experienced no growth.

In addition to land values, the cost of building dealership property is also a significant influence on the balance sheets. While there is inevitably great variation in build cost depending on the specification of the property, build costs for dealerships are typically more than 50% greater than for retail warehousing.

A notable range exists in the build costs for dealership property between the regions. London’s build costs of dealerships remains the most expensive at £91 per sq ft, while the south east, Scotland and northern regions all have costs around £83/£84 per sq ft.

Yorkshire and Humberside, East Anglia and the south west have build costs of £78-79 per sq ft, while the Midlands, north west and Wales have costs between £73 and £75 per sq ft. Northern Ireland is the exception with costs at £54 per sq ft.

These costs are for a shell and core specification, excluding fit-out which can significantly inflate costs.

Overall in the UK, build costs of dealerships have risen by 3.4%. London has shown the strongest growth at 11.2%, while the next notable increases were 6.6% in the south west and 4.4% in East Anglia.

There has been more subdued build cost inflation in the other regions, while the only region to record a decline in costs was the north west (-2%).

There is a relationship between land value and new-build costs across most of the regions, with the high land values in London and the south east matching high build costs.

However, there are some exceptions. The northern and Scotland regions have high build costs compared to land values, but in the Midlands there are relatively strong land values, yet low build costs.

It is worth noting that there is a much greater deviation in land values than there is in build costs.

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