Commercial market decline; Commercial Property.

OVER the next two years commercial property capital values could fall by a further 25% - taking the peak to trough decline to at least 50%- thanks to a sharp drop in rents, according to the RICS Commercial Property Forecast published this week.

RICS expects the commercial property market to see at least 16% declines in capital values in 2009 and a further drop of up to 10% in 2010. Since the onset of the credit crunch in June 2007, capital values have already fallen 25% and with more falls to come, the cumulative downturn in prices will exceed those experienced in the 1970s and 1990s.

Rising defaults and credit spreads will constrain a near term recovery in financing, preventing any recovery in the investment market over the next couple of years. Low interest rates, recovering global growth and improving valuations relative to other asset classes should see the downturn gradually begin to reverse on 2011.

The biggest declines are likely in the office sector with capital values expected to drop a further 30-35% bringing peak to trough declines in excess of 60%. Employment in banking, finance and insurance has accounted for the lion's share of job creation since the millennium although has moved into decline over the past year. An acceleration in this trend is set to weigh on demand for office space, undermining rents.

The retail market is also likely to suffer a similar fate and see capital values drop by a further 25-30% as consumers tighten their belts.

The retail warehouse market is feeling the impact of the downturn and a slowing of big ticket purchases is expected as transactions in the housing market remain subdued. Capital values declines in the industrial sector are expected to be less pronounced, falling 15-20% over the next three years, helped by a weakening pound and slow recovery in the global economy towards 2011.

Price declines will be exaggerated by falling rents and an increase in distressed selling as refinancing pressures bite. RICS expects rents to fall by 10%in 2009, 4% in 2010 and 3% in 2011.

The office sector is expected to be hit hardest with a 16% decline in rents in 2009, 11% in 2010 and 6% in 2011. With consumer confidence at its worst level for more than a decade and consumer spending falling, retail rents will suffer. RICS expects rents in the retail sector to fall by 7% in 2009, 6% in 2010 before stabilising by 2011. Rents in the industrial sector will be marginally flatter than elsewhere but even so rents are expected to fall by 6% in 2009, 5% in 2010 before beginning to edge upward by 2011.

Commercial property sector spokesman for RICS North East, and partner in JK Property Consultants LLP, Kevan Carrick said: "Although the forecast is bad news, it is not unexpected and the North East market is holding up well given the national picture. The market has turned from a sellers' market to a buyers' market and those with cash to invest can offer lower prices and get a good deal. As a region we must not panic or be too nervous about this forecast, but be confident to prepare for better times ahead."

Commenting on the national picture, RICS senior economist Oliver Gilmartin said: "We are only half way through the price correction in the commercial property market with values set to fall through 2009 and 2010 as rental declines gather pace. Transaction activity is set to rise as more sellers are willing to accept lower bid prices.

"On a positive note, the rapid re-pricing across the market has pushed UK yields to among the highest in the developed world with a very wide gap emerging compared to finance costs. For unleveraged investors (like pension funds), high yields provide good long term value especially for prime properties."