Thursday August 13, 11:50 AM

ANALYSIS - UK property in recovery? Don't believe the hype

By Sinead Cruise and Daryl Loo

LONDON (Reuters) - Hold the celebrations and put the champagne away. A sustained recovery in the UK commercial property market is likely more distant than it might seem, as lingering economic hazards threaten a long-awaited rebound.

Figures last week from the world's largest property broker CB Richard Ellis, a precursor to benchmark data from Investment Property Databank due on Friday, showed UK values rising for the first time since peaking in June 2007.

Coupled with a 75 percent surge in real estate stocks since March, the positive signals have fired hopes of an imminent end to two years of turmoil in the market, where prices have almost halved since a summer 2007 peak.

But some experts fear a burst of unjustified optimism has replaced the blind panic which floored annual investment turnover by more than 50 percent to 22 billion pounds ($36 billion) in 2008.

"We had sleepless nights (in March) because we did not understand so much bearishness, those nights are unfortunately back. This time it is the violent bull run that wakes us up too early," JPMorgan property analyst Harm Meijer said.

The weakening economy, a continued scarcity of debt and an expected withdrawal of government-engineered drivers such as low base rates mean a long-lasting recovery, with rising values supported by improving rents, could still be years away.

The FTSE 350 Real Estate Index, led by blue chips Land Securities and British Land, has nearly doubled since hitting a lifetime low on March 10. But analysts like Nomura's Mike Prew say the rally is built on shallow foundations.

"We are mindful that after the 1990s crash, real estate prices suffered a relapse with ... soggy pricing until rental growth was comprehensively restored some two years later," Prew said, explaining Nomura's contrarian downgrade of the sector from "bullish" to "neutral" last week.

"Our concern is that real estate prices will become distorted by artificially supported economic activity. (The UK REIT sector) ... no longer appears inexpensive to us," he said.

RISKY BETS

Data from brokerage Cushman & Wakefield shows prime property yields dropped by 24 basis points to 7.17 percent in the second quarter, raising concerns landlords are no longer receiving an adequate risk premium versus the 3.8 percent for 10-year Gilts.

This investment risk centres around rental security, which has fallen sharply as the recession forces weak tenants out of business and stronger tenants to dump space, analysts said.

Cushman's quarterly figures to end-June show an acceleration in rental falls, while the take-up of UK office space has plunged by around 50 to 60 percent in the year to June 30, pushing peak-to-trough forecasts for prime rents down by a fifth.

"It looks like a W-shaped (property) recovery could be on the cards, caused by short spikes in demand and a subsequent realisation that the economic fundamentals remain weak," said Mike Riordan, head of investment at brokerage Gerald Eve.

Moreover, UK buyers are still struggling to secure debt from traditional lenders such as Lloyds Banking Group and Royal Bank of Scotland, who continue to battle their own funding problems and costly exposure to UK commercial mortgages.

"People need to be wary of getting too carried away with the potential of the upturn, because the problems of refinancing are lurking over the rest of this year and into 2010," Ed Stansfield, property economist at Capital Economics, said.

"It's an uncertainty for the market and a return to normal lending conditions could be many years off," Stansfield added.

Other economic commentators suggest the surprise 50 billion pound expansion of the UK's quantitative easing programme last week is evidence the central bank sees a double-dip recession as inevitable, compounding risks of an early return to real estate.

"We judge that the Bank of England correctly understood that it is simply taking longer for the stimulus to turn the economy than it had hoped," Keith Steventon, head of research at BNP Paribas Real Estate UK, told Reuters.

"We've been here before. We know it takes time. It's not zeal we want, but patience."