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Commercial property values will halve and rents and occupancy rates will suffer steep falls as the once-buoyant sector faces meltdown in 2009, according to property experts.
Severe overcapacity in London after a rash of speculative office building and a collapse in demand is seen as the main reason for the expected crash.
Hedge funds in Mayfair and St James's have led the way after many emerged as some of the biggest losers from the credit crunch. Rents of £105 to £110 a square foot for the s****iest offices have dropped to £95 in the last couple of months, according to agents Jones Lang LaSalle.
Offices in the City and the West End have also been hit by the collapse in the banking industry and other sectors. Rent-free introductory offers are becoming more popular and now average three years compared with 18 months at the beginning of the year. Analysts at Capital Economics said rents in the West End were down 8% from their peak, according to the latest IPD index.
The fall in commercial property values has already helped claim some notable scalps. The troubles that led to the demise of David Ross as chairman of Carphone Warehouse are rooted in the falling value of his commercial property investments across Britain and John Duffield, one of the City's most colourful characters, has been forced to give up his New Star Asset Mangement empire after it was weakened by the collapse of one of its high-profile property funds.
This story is reflected across the property development industry with most of the big firms, including Land Securities, British Land and Hammerson, suffering huge drops in property values and plunging share values. Almost the entire sector has come under the gaze of speculators ready to bet that things will get worse. Hammerson has 16% of its equity on loan to hedge funds, all them believed to be shorting its shares to profit from further falls in values.
The latest figures show the rest of the country is beginning to follow London as rental values across the entire commercial property sector fell in November for the first time since 2004.
Capital Economics warned that a 0.5% fall in rents year on year in November was only the beginning of a more general malaise. Though many developers downed tools in the spring and mothballed hundreds of commercial developments, over-supply of offices remained a key factor.
"We still expect rental values to fall substantially, as weak demand overwhelms any beneficial effects of a smaller supply pipeline," it said. Analysts who have warned for years that commercial property was a bubble waiting to burst remain sceptical that it will recover before 2010 or even later. Mark Dampier, head of research at Hargreaves Lansdown, advises investors to stay away while the credit squeeze persists.
"The whole of the property market - commercial and residential - is built on credit and when there is a credit crunch it is unable to function properly."
Despite his protests small investors ploughed at least £20bn into commercial property funds in the five years to 2007. Much of that money, for the time being at least, has disappeared.
Double whammy
For Britain's largest property funds that has meant suffering a double whammy of falling capital values and a surge in redemptions by investors. New Star's UK property fund was worth £2.2bn in 2007 against £1.1bn last month. In 2007 it had 30% in cash as a cushion against further falls in values and to cover redemptions. Now that figure is nearer 10% and it is busy selling assets.
Aviva's Norwich Union property unit trust was worth £4.4bn last year. That figure has dived to £1.87bn and its cash cushion is down to 5%.
The derivatives market for property swaps provides a good indicator of where capital values in the sector are heading, according to Matthew Oakeshott, who advises pension fund consultant OLIM. Oakeshott, a Liberal Democrat Treasury spokesman in the House of Lords, said the swaps market, usually based on the IPD All Property index, is increasingly used by property fund managers looking to fix their returns. According to figures for November, the market is pricing in a decline of 51% in values from peak to trough, signalling a further 32% decline in capital values.
Picky buyers
"Fifty per cent off capital values is a realistic estimate for commercial and residential property prices from last year's peak," Oakeshott said. "Income yields for shops, warehouses and offices let to strong tenants on long leases are attractive now at about 8%, more than double long gilt yields. But the banks have bucketfuls of property they must sell, so we few cash buyers are being very picky.
"The real danger to commercial property values is from falling rents. Investors should steer well clear of London offices, out-of-town retail warehouses and anything with flaky tenants on short leases which you can't re-let."
Few analysts predict disaster for the major property developers, which despite the short sellers, the lack of borrowing and the continuing slide in values appear to have enough reserves to survive.
Investors may also see a light in predictions by economists at Lombard Street Research that rising yields will soon bring back not only Lord Oakeshott and his pension fund investors, but from the second half of next year wealthy foreign investors keen to acquire prime properties cheaply.
That is unlikely to happen until rents stabilise and unemployment begins to bottom out. Vulture funds, some financed by Chinese and Middle Eastern money, have been sitting on the sidelines waiting for improved conditions. They may be forced to stay put for another year.
Victims of the crunch
David Ross
The disgraced Carphone Warehouse founder was forced to use his share portfolio as collateral for loans to support investments in commercial property, where it is thought a big slice of his estimated £900m personal fortune is invested. His property vehicle Kandahar owns the 52,000-square-metre Drake Circus shopping centre in Plymouth, and other regional centres.
John Duffield
Duffield is ceding control of up to 95% of his firm New Star Asset Management to a consortium of banks led by HBOS. Struggling under debts of £240m, New Star's International Property fund was suspended, hastening the fall of a group that once had £20bn under management.
Metrovacesa
The Spanish property firm bought the HSBC tower at Canary Wharf last year for a record £1.09bn at the top of the market. But it recently sold the tower back to the bank for £838m after prices collapsed in Britain and Spain.
Mapeley
HM Revenue & Customs is closing 90 tax offices around the UK, leaving its Guernsey-based landlord Mapeley with vacant office space for 3,400 staff in the middle of the recession. Mapeley, which runs 600 tax offices, was already making a loss. After the announcement its share price plummeted by 97%, from £40 to £1.20.
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