By Daniel Thomas, Property Correspondent
Published: July 8 2010 19:06 | Last updated: July 8 2010 19:06
The west’s next real estate boom may be further away than ever. A fall in the price of complex derivatives linked to commercial property shows that investors believe that the UK market – predicted last year to recover strongly – is heading for a slide.

Renewed pessimism about the global economy has turned sentiment on its head in Britain, which along with other big property markets across Europe could come under pressure as a result of governments’ fiscal austerity drives, dealers say.

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The pricing of UK property derivatives – tradeable instruments based on an industry benchmark index – has weakened in the past three months, with a pronounced dip in pricing for contracts based on next year’s real estate returns.

Property derivatives are seen by some investors as a barometer of market sentiment, for the near term at least, given the ability to buy or sell contracts based on investor expectations of total returns from the benchmark index.

Derivatives trading suggests that UK commercial real estate is likely to see a fall in value in the next few years, with the prospects for rental growth diminishing.

Falling prices reflect fears about a double-dip recession and the effect of another downturn on real estate. Sentiment has shifted sharply since last year, when traders were factoring in strong growth in returns for 2010 and 2011.

The UK market in commercial property derivatives is one of the world’s most established. While derivatives trades are carried out based on other European and US markets, the volumes traded elsewhere are not sufficient to be seen as an indicator of sentiment.

Bill Bartram, director at JC Rathbone, said the numbers showed that the market was becoming increasingly wary about another dip in property values. In the past month alone, expectations for total returns next year have moved from 4 per cent to 2 per cent, implying a fall in capital values of about 5 per cent.

Trading for the 2010 contracts has also seen prices tail off, with total returns dropping from about 12.5 per cent in April to 9.5 per cent, which means there is not expected to be much further growth this year. There has also been a fall in the pricing for contracts based on market performance in 2012 and 2013.

The fall in the price of derivatives reflects recent falls in the value of other assets that are backed by physical property, such as shares in property companies.

Nomura has forecast a 4 per cent “relapse” in commercial real estate values in the second half of this year – a fall that is being priced into equities too. Shares in UK listed property companies have tumbled 15 per cent since the beginning of the year, while their European counterparts are down almost 20 per cent over the same period.

The listed real estate sector is now trading at a 16 per cent average discount to net asset values, a bigger discount compared with last year when many companies were trading close to the par with their net asset values.

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