The UK all-property DTZ Fair Value Index stands at 38 for quarter two 2010, suggesting that many UK commercial property markets are over-priced and do not offer attractive returns for investors over the next five years.

An index score below 50 indicates there are more markets categorised as cold (unattractive to investors as expected returns are below risk-adjusted required returns) than hot (attractive to investors as expected returns exceed risk-adjusted required returns).

Although the all-property score of 38 for Q2 2010 represents an improvement from 33 in Q1 2010, UK markets are not as attractive as they were this time last year, when they scored 55 in Q1 2009.

The decline in appeal is a result of yield compression driven by investors who took advantage of the rapid re-pricing which occurred during 2009.  This, coupled with a renewed focus on new supply coming on stream, means the outlook for the UK market is currently less alluring than last year.

The global DTZ Fair Value Index for Q2 2010 stands at 62, well ahead of the UK score of 38. This highlights the fact that markets in Europe (49), Asia Pacific (67) and the US (89), offer more attractive investor opportunities than the UK, which in large part has already experienced its recovery and has fewer markets with prospects of rental growth than the rapidly growing economies in Asia.

Hans Vrensen, global head of research at DTZ, says: “We have devised the DTZ Fair Value Index to help investors to allocate funds to commercial property, particularly in this highly uncertain market environment. The indices take into account macro-economic factors such as the European sovereign debt crisis. The index quantifies the impact of these trends on the attractiveness of individual markets over a five-year investment period – providing investors with our foresight.”

The UK all-property Index score masks significant differences between sectors, and the warm retail and industrial markets are currently being dragged down by weaker prospects for the office sector. 

Pricing in UK office markets has generally overshot fair value, as shown by the current UK office Fair Value Index score of 25. This score has fallen sharply from its peak of 71 in Q3 2009, when investors were able to take advantage of historically low pricing following sharp falls in capital values in late 2008 and early 2009, before yields came in. This, combined with the expectation of minimal rental growth in coming years, particularly in regional office markets outside of London, will limit the returns that investors can expect from this sector.

Despite general overpricing, a limited number of markets are still regarded as hot prospects, with London City offices and London West End retail markets standing out as offering attractive returns.

Tony McGough, global head of forecasting and strategy research at DTZ, says: “The London City office market is expected to experience continued strong rental growth over the medium term, despite the resurgence in development, with its rapid recovery from the economic downturn. This will provide investors with solid capital value growth and consequently attractive returns over the next five years. In contrast, regional office markets have also shown strong capital value recovery over the past year. Combined with limited rental growth, this results in modest future capital value uplifts and consequently makes most UK regional office markets less attractive.”