UK property yields and rents look to be "heading for the doldrums" as the influences driving capital movements plateau, delegates at the IPD/IPF/PDIG (Investment Property Index/Investment Property Forum/ Property Derivatives Interest Group) Quarterly Q2 Briefing were told on Tuesday morning, in London.

At the breakfast briefing, IPD Research Director Malcolm Frodsham told delegates: “The early rapid recovery is behind us now, which suggests we may be heading for the doldrums or a convergence across markets - - income returns will likely make up the vast bulk of investor returns in the second half of the year.”

According to the IPD UK Quarterly Property Index, yields have fallen 68 basis points (0.68%) in the first half of 2010, which comes after steeper falls of 106 basis points over the previous six months. Overlaid upon this, has been nine consecutive quarters of rental decline, amounting to a -10% fall. “We have probably seen the peak of the 12-month returns at 25%; the yield rally has come to an end with moderation across all sectors,” Frodsham added.

The net effect of the yield and rental movements was a second quarter capital growth of 1.8%, with a compounded 14.6% capital return over four consecutive quarters of positive growth.

Frodsham added: “A period of muted rental movements and little further compression in yields creates a dilemma for investors seeking to out-perform the index: enhance the security of income with longer unexpired lease terms and secure covenants or edge up the risk profile to receive a higher running yield?

“The position so far is very segment-specific. The better (or less negative) rental value growth and more secure income has enabled lower equivalent yield standard shops, offices outside of central London and industrials to out-perform assets in the same segment with higher equivalent yields.”

Global property derivatives: encouraging year end

Following the quarterly direct market update, Derivatives Client Manager Kate Pedersen at IPD delivered the IPD Global Property Derivatives trading volumes for the second quarter.

Global property derivatives trading volumes sunk to their lowest quarterly level for over four and a half years, with just £300m executed in 62 trades, IPD confirmed. The trading activity was split 50 UK trades worth £246m and 12 trades worth £54m against French indices.

Ahead of the briefing Nick Scarles, Chairman of the IPF PDIG and Grosvenor’s Group Finance Director, said: “The reduced level of property derivatives activity was widely anticipated given the economic uncertainties faced by financial and property markets, but also reflects pricing being closer to many investors' forecasts, reducing speculative trading.

“I anticipate that the level of activity in property derivatives will continue to reflect the level of uncertainty in the broader economic markets, but in the short term there are clear signs that property derivative pricing is moving to a level likely to be attractive to speculators and investors who find physical product at ‘fair’ prices hard to find."

“The worsening in trading activity in the last quarter was to be expected,”“Over the three months to June, the fear of counter part risk was reenergised by the prospect of sovereign default risk in Greece, stringent bank stress testing provisions by the ECB as well as the prospect of EU regulations. Against this background, trading activity was unlikely to recover compared to the first quarter. explained Pedersen.

“However, looking forward the mood is tangibly more upbeat. The Greek crisis appears in hand, the fear of further sovereign debt default has eased, while broader sentiment is less volatile. All of which points to a more robust third quarter for property derivatives trading.”

In the Q&A later in the briefing, Phil Ljubic, head of property derivatives trading at RBS said the third quarter looks very encouraging. “We are seeing groundswell of activity over last month with more trades in first month of Q3 than we saw over the entire second quarter - - that is, more than £250m worth of trades. So we are seeing some quite big volumes. They consist mainly of all property trades, but we are looking to do more sector and sub-sector, particularly with hedge funds.”

Morgan Stanley’s Benoit Pinguet added: “If you are IPD benchmark investor you can buy a note for IPD return plus extra, which locks in your return if you are worried about the downside scenario.”