Executive Summary. Contents. 1 Executive Summary 2 All Property Forecasts 3 Investment Activity 4 Retail 5 Offices 6 Logistics & Industrial

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1 spring 211 Real Estate Investment Forecasts Q1 RESEARCH & FORECASTING uk Real Estate Investment Forecasts Q1 Contents 1 Executive Summary 2 All Property Forecasts 3 Investment Activity 4 Retail Offices 6 Logistics & Industrial Demand for institutional grade assets is outstripping supply by a wide margin. Gilt rates are expected to remain low in 211 and 212 and will give scope for further yield compression. Research & Forecasting Walter Boettcher walter.boettcher@colliers.com Executive Summary Despite the appearance of relative price stability with little change in capital values over Q1 11, the UK property investment market remains highly stressed. Demand for institutional grade assets is outstripping supply by a wide margin. Foreign and domestic funds are well capitalised and are looking to increase exposure to property to diversify investment portfolios. Foreign private investors continue to pursue safe haven and wealth preservation strategies in response to political and economic instability worldwide. IPD reports that total returns for All Property reached.1% in 21, mainly in response to yield driven capital growth. Equivalent yields fell by 7 bps from 7.8% to 7.1%, generating capital growth of 8.3%. In 211, total returns are forecast to fall to 8.%. Limited yield compression, on the basis of fewer prime transactions, means that capital values will grow by only 1.8%. Gilt rates are expected to remain low in 211 and 212 and will give scope for further yield compression. Prime Central London offices are still a central target of institutional investors, both domestic and foreign. Foreign investors continue to take the lion s share of the Central London market by outbidding domestic investors. The retail sector is subject to serious downside risks in the short term. Real disposable income contracted on an annual basis in 21 for the first time since 1981, leading to a fall in household spending. Retail property investors are frustrated by a lack of investment grade product. This is true across all sub-sectors. A lack of product is driving yields lower by virtue of intense competition for assets that do come to market. Investor interest in the industrial sector is focused on prime retail distribution warehouses, especially those let to supermarket chains with RPI-indexed leases, and South East based multi-let industrial parks. Both are perceived as offering secure income and are much sought after by UK institutions. Summary Commercial Property Forecasts Annualised ERV Growth (% pa) Capital Growth (% pa) Total Return (% pa)

2 real estate investment forecasts Q1 Spring 211 All Property Forecasts Despite the appearance of price stability, the UK property investment market remains highly stressed. Foreign private investors continue to pursue safe haven and wealth preservation strategies in response to political and economic instability worldwide. Despite the appearance of relative price stability with little change in capital values over Q1 11, the UK property investment market remains highly stressed. Demand for institutional grade assets is outstripping supply by a wide margin. Foreign and domestic funds are well capitalised and looking to increase exposure to property to diversify investment portfolios after the substantial recovery of equities in 21. Secure income and risk diversification are important themes with property offering an alternative to equity market volatility and low yielding bonds. Gilts are expected to remain low yielding for some time. FOREIGN DEMAND REMAINS STRONG Foreign private investors continue to pursue safe haven and wealth preservation strategies in response to political and economic instability worldwide. Turbulence in the Middle East has been accompanied by investment flows into UK gilts and other sovereign bonds, as well as into UK property assets, especially in Central London where yields have fallen to pre-recession levels. OPEC announced that recent oil price rises may result in revenues of $1 trillion in 211, topping up sovereign coffers. Strong economic performance in South Asia and the Far East is also generating significant cash reserves. Closer to home, new episodes of eurozone financial distress and on-going policy uncertainty is also encouraging UK investment inflows. DEMAND FOR SECONDARY LIMITED BY RISK AVERSION AND FINANCE In contrast, demand for secondary and tertiary assets is very weak as institutional investors are extremely risk averse given their perception of weak occupier markets, continued economic uncertainty and concerns about local and regional economic impacts of UK government fiscal policies. Debt finance is showing few signs of traction and is absent for non-prime assets. The latest Bank of England Credit Conditions Survey shows that finance availability to real estate is contracting and that this trend is expected to continue through Q2 11. Meanwhile, many non-prime assets, held on bank balance sheets in the hope of a further recovery in value, are becoming obsolete. Colliers International forecasts for All Property for the period 211 to 2 show subdued returns. Total returns in 211 will fall to 8.% as relatively limited yield compression on the basis of fewer prime transactions means that capital values will grow by only 1.8%. Rental values are forecast to fall again by a marginal.4% in 211, but will return to positive growth from 212 to the end of the forecast horizon. This rental growth is likely to encourge further yield compression in 212 and 213 which, in turn, will spur capital growth and, lead to stronger total returns of 8.4% and 9.8% respectively. figure 1: Forecast Total Returns by Sector Retail Office Logistics & Industrial All Property Contributors: Investment Valuation Russell Francis russell.francis@colliers.com Fund Management Nigel Holroyd nigel.holroyd@colliers.com Adrian Payne adrian.payne@colliers.com Annualised National Investment André James andre.james@colliers.com p. 2 Colliers International

3 real estate investment forecasts Q1 spring 211 Figure 2: London Office Investment (% share), Property Data Ltd % Share of London Office Investment Market Total ( bn) Institutions ( bn) Foreign ( bn) Institutions (% share) Foreign (% share) Source: Property Data Ltd figure 3: Net value of investment billion Q1 9 Q2 9 Source: Property Data Ltd UK Institutions Overseas Investors Q3 9 Q4 9 Foreign Private Investors Q1 1 UK Institution Q2 1 Q3 1 Quoted Prop Co Q4 1 Q1 11 Investment Activity Aggregate levels of property investment remain constrained by a lack of willing sellers of quality product as well as by a lack of finance for secondary and tertiary assets. Demand is coming from the full range of investors, although those groups reliant on debt finance are unlikely to make much headway. MOMENTUM OF Q4 1 HAS CARRIED OVER TO Q1 11 Property Data reports that the value of transactions in Q1 11 ( 9.bn) is up by % on Q1 1 ( 6.3bn). A few large transactions have made the difference as the number of deals fell by 23% from 432 to 33 over the same period. The data also suggests that the pace has kept up on a month by month basis, lending some merit to the argument that supply is less constrained than perceptions would suggest. COMPETITION FOR QUALITY STOCK IS FIERCE By net transaction totals, private investors continue to sell assets acquired, no doubt at substantial discounts in 28 and 29, during the period of fund redemptions. The funds remain well financed and are back in the market and competing with overseas investors with some success in the prime part of the market. In the London office investment market, UK institutions struggle to compete with foreign investors, although the institutional share of the market is up from 16% in 21 to 31% so far in 211, the highest level since 26. Meanwhile, property companies are showing signs of returning to the fray after restoring their balance sheets, although a lack of debt finance is likely to limit their overall impact. DEBT FINANCE NOT LIKELY TO MAKE A MEANINGFUL CONTRIBUTION The general view among property investors is that finance is not likely to make a meaningful contribution to the market for some time. Interest rates are likely to remain low which will facilitate, to some degree, large refinancing challenges. Banks will increasingly look to private equity funds to mop up non-core loan portfolios at a discount as banks continue to deleverage balance sheets and at the same time try and address tightening controls on capital ratios. Increases in stock being sold by bank appointed receivers is widely anticipated and could have an impact on overall commercial property values. The general perception that the market is constrained by supply might be countered by the argument that demand is excessive. Colliers International p. 3

4 real estate investment forecasts Q1 spring 211 Retail The retail sector is subject to serious downside risks in the short term given harsh trading conditions. Household spending is falling. Real disposable income contracted on an annual basis in 21 for the first time since Great uncertainty with respect to employment and the impact of government spending cuts has encouraged households to spend less and save more. The household savings ratio was.4% in Q4 1 in contrast to a negative savings ratio of -.9% prior to the recession in Q1 8. Consumer sentiment has changed dramatically in the last six months with the Nationwide Consumer Confidence Index recording its lowest reading ever in February 211. Retail sales have fared better than expected, although the BRC has just reported the worst fall in total retail sales for 16 years in March, down 3.% on a like-for-like basis. Discounting remains the key ingredient in driving sales volumes. Consequently, retail trader margins remain under pressure and retailers continue to press landlords for rental concessions. NEGATIVE PRESS CLIPPINGS NOT HELPING The retail sector has seen a few recent failures, with Alworths, Easy Living Furniture, Oddbins and Officers Club all entering administration. HMV continues to issue profit warnings and is reported to be contemplating a sale of Waterstone s, and JJB s CVA negotiations continue to unsettle the market. Despite these negative press clippings, the IPD retail income void rate remains relatively low at.9%, not far off its 1 year average of.4%. The level has increased from a recent low of.1% in November 21, although a large scale release of retail space onto the market, as seen in 28 and 29, is not anticipated. Outside of London, retail property leases are reported to be under pressure, with incentives possibly increasing again and landlords in new CVA negotiations. Regional retail rents are still contracting. London continues to buck the trend with record rents still being achieved in the West End. Retail Forecast Summary Annualised ERV Growth (% pa) Capital Growth (% pa) Total Return (% pa) INVESTORS FRUSTRATED BY LACK OF QUALITY PRODUCT Retail property investors are frustrated by a lack of investment grade product. This is true across all sub-sectors. A lack of product is driving yields lower by virtue of intense competition for assets that do come to market. High street yields are near 4% in Central London as foreign investors have bid up prices. Regional centre prime high street assets are also achieving sub % yields. Prime supermarkets with RPI indexation are especially sought after and are trading at yields around 4.2% to 4.%. Retail warehouses also continue to be of great interest with yields forecast to continue to fall as competition remains very keen for limited product. Shopping centres will show considerable weakness in 211 with weak rental growth and limited quality product coming to the market. An increase in the availability of secondary assets is expected as banks push more stock on to the market. The shopping centre development pipeline is still at a standstill, hence shopping centre values are expected to increase as a shortage of space becomes apparent later in our forecast horizon. SUPERMARKETS OFFER THE GREATEST RETURN Supermarkets are forecast to offer the greatest total return over our forecast horizon at 7.1%. This may, however, substantially understate the returns potential for prime supermarkets due to the heterogeneity of the IPD supermarket portfolio. Shopping centre returns will follow at 6.8% due to strengthening performance with yield compression beginning in 212 and positive rental growth following in 213. Returns for retail warehouses, which have already seen substantial yield compression and capital growth, will moderate as will standard shops. Total returns over the forecast horizon are expected to reach 6.4% and.% respectively. figure 4: Forecast Total Returns by sub-sector Standard Shops Shopping Centres Retail Warehouses Supermarkets Annualised Contributors: Investment Retail In-Town André James andre.james@colliers.com Retail Out-of-Town Charles Watson charles.watson@colliers.com Contributors: Agency Retail In-Town Paul Moody paul.moody@colliers.com Retail Out-of-Town Colin Dunkerley colin.dunkerley@colliers.com Colliers International p. 4

5 real estate investment forecasts Q1 spring 211 Offices UK property looks cheap to foreign investors. The strength of tenants is paramount. PRIME CENTRAL LONDON REMAINS A TARGET Prime Central London offices remain a principal target of institutional investors, both domestic and foreign. Foreign investors continue to take the lion s share of the Central London market by outbidding domestic investors. In 21, foreign buyers took 3% of transactions by value, in contrast to 31% by UK institutions. Exchange rates no doubt play a role. Sterling s trade weighted average is still down 23% from its 27 peak. Simply put, UK property looks cheap to foreign investors. This is especially true of West End assets, where foreign private investors have pushed initial yields down to 4%. Interest across all asset classes in Central London is set to continue for the foreseeable future as investors flock to exploit the buoyancy of London s micro economy. THE STORY IS DIFFERENT IN THE PROVINCES Outside of Central London the story is different. While the rate of company failures has fallen back to pre-recession levels, there is fear that regional centres will bear the weight of government cuts. Not only will government occupiers be cut back, but also companies that rely on government contracts. Corporate occupiers are in better shape, many with significant cash reserves. Economic uncertainty has, however, meant that few have been willing to deploy this cash for business expansion purposes and make commitments to new leases. Vacancy rates have improved but remain elevated with most markets well above 1% and some near 18%. SECURE INCOME IS paramount Despite these worries, there is strong investment demand for prime offices in regional centres provided that these assets are accompanied by secure income. The strength of tenants is paramount, with premiums being paid for long RPI-linked leases to UK government departments and international corporate occupiers whose trading performance is not linked solely to trends in the UK economy. This is also true of institutional grade secondary assets and business parks. Investors and developers have been watching the regional markets very carefully, especially with respect to distressed stock that may be released by banks. Many observers anticipate greater numbers of sales by receivers as the year progresses as banks choose to clear more non-core assets from their balance sheets. Pricing uncertainty is great as many secondary assets are becoming increasingly obsolete and might be considered redevelopment opportunities rather than as long term income generating assets. Yields could move out substantially. Contributors: Investment Offices City of London Andrew Whitaker andrew.whitaker@colliers.com Offices West End Nick Pemberton nick.pemberton@colliers.com National Business Space Michael Kershaw michael.kershaw@colliers.com Contributors: Agency Offices City of London Julie Rees julie.rees@colliers.com Offices West End Robert Few robert.few@colliers.com Offices National Mark Taylor mark.taylor@colliers.com CENTRAL LONDON TO OFFER GREATEST RETURNS Central London offices are predicted to offer the greatest returns over the forecast horizon. These strong returns are based on the assumption of strong rental growth throughout the forecast period, as well as continued yield compression as investor interest remains very strong. Equivalent yields for offices as a whole are forecast to fall in 211 by 3 bps. By the end of 212, rental growth should be more firmly entrenched as the UK economy strengthens and pent up occupier demand begins to drive the market. Offices Forecast Summary Annualised ERV Growth (% pa) Capital Growth (% pa) Total Return (% pa) FIGURE : Forecast Total Returns by sub-sector 2 City West End Rest of UK Office Parks Annualised Colliers International p.

6 central real estate london investment spring forecasts 21 research Q1 spring & forecasting 211 Logistics & Industrial Investor interest in the industrial sector is focused on prime retail distribution warehouses, especially those let to supermarket chains with RPI-indexed leases, and South East based multi-let industrial parks. Both are perceived as offering secure income and are much sought after by UK institutions. Prime retail distribution warehouses are in increasingly short supply in core demand areas, such as London and the South East. Additionally, the complete lack of new development has meant that many of the existing facilities on offer to either occupiers or investors are increasingly outdated and of insufficient specification for the latest generation of logistics technology, especially to service the rapidly growing and sophisticated internet sales supply depot. SHORTAGE OF HIGH SPEC DISTRIBUTION SPACE The shortage of high specification distribution space is sufficient to have generated a few high profile design and build forward funding deals. An almost complete lack of development finance has meant that this trend in pre-letting has not yet gained traction, although a few operators and developers are looking again at plans that were shelved prior to the recession. ECONOMIC REBOUND SUPPORTING MULTI-LET INDUSTRIAL PARKS A strong rebound in export growth driven by weak sterling, as well as a substantial recovery in world trade, has resulted in very strong growth in manufacturing and industrial production over the last two quarters. The latest purchasing manager indices suggest that this growth is very likely to continue and will support an increasingly stable set of small and medium sized industrial occupiers. Multi-let industrial parks should, therefore, see some benefit. RENTAL GROWTH REMAINS WEAK Rental growth in the industrial sector remains weak, despite improving conditions in the general industrial economy. Rents are predicted to fall by 1.3% in 211, before positive growth is established in 212. Industrial rental growth is forecast to grow by an annualised rate of 1.6% over the forecast horizon, with the strongest growth coming through in 214 and 2. TOTAL RETURNS GENERALLY BUOYANT THROUGH 213 Total returns are expected to reach 9.7% in 211 as yields harden in response to competition for limited product and investor expectations of strengthening rental growth and improving conditions in the industrial sector generally. Distribution warehouses will fare better with returns reaching 1.9%. Industrial sector investment is predicted to offer good returns over the forecast horizon at 8.%, behind offices at 9.8%. 48 offices in 61 countries on 6 continents United States: 13 Canada: 39 Latin America: 17 Asia Pacific: 26 ANZ: 168 EMEA: 9 LONDON - WEST END 9 Marylebone Lane London W1U 1HL Contributors: agency Logistics & Industrial Len Rosso len.rosso@colliers.com logistics & Industrial Forecast Summary Annualised ERV Growth (% pa) Capital Growth (% pa) Total Return (% pa) Disclaimer: This report gives information based primarily on published data which may be helpful in anticipating trends in the property sector. However, no warranty is given as to the accuracy of, and no liability for negligence is accepted in relation to the forecasts, figures or conclusions contained in it and they must not be relied on for investment purposes. This report does not constitute and must not be treated as investment advice or an offer to buy or sell property. April Colliers International is the licensed trading name of Colliers International UK plc. Company registered in England & Wales no Registered office: 9 Marylebone Lane, London W1U 1HL. Figure 6: forecast Total Returns by sub-sector Standard Industrials and Parks Distribution Warehouses Annualised Accelerating success.