Property stocks 'will rally by 20 per cent in first half'

Shares in listed property companies will rally by at least 20 per cent in the first half of this year, analysts at Morgan Stanley forecast yesterday, arguing that the state of the sector is "so bad, it's good". The report provided welcome respite for bombed-out property stocks, which rose sharply following its publication.

The prediction, underpinned by continued speculation that the Bank of England will be forced this year to cut interest rates by about 100 basis points to avert a recession, propelled British Land to fourth place on the FTSE 100 leaderboard.

The firm's stock, which lost more than 38 per cent of its value in the past 12 months, closed up 47.5p or just over 5 per cent at 968p.

Hammerson, which gained 21p or 2 per cent to close at 1044p, Brixton, which gained 18p or almost 6 per cent to close at 323.75p, and Segro, which climbed 25.5p or 5.3 per cent to close at 499p, also benefited.

Martin Allen's note said: "We believe the current UK property credit cycle, and the consequent pricing distortions, are of a comparable scale to the major cycles experienced in the early 1970s and the late 1980s/early 1990s.

"With UK property shares having peaked exactly at the end of 2006, we are now just over a year into a bear market that we think is likely to last for three years, as it did in the two previous downturns.

"However, we find it striking that both in the UK property share bear markets of the late-1980s/early 1990s and the early 1970s, after 13 months there was a short, sharp, counter-trend rally that lasted for five months before the bear market resumed in earnest."

The comparison with past downturns reveals that these rallies were accompanied by sharp cuts in interest rates. And although earlier reductions were more aggressive, falling in the range of 200-250 basis points, Morgan Stanley estimates that a cut of 90 basis points in the near future would have a proportionally similar effect.

Morgan Stanley's longer-term view, however, is less optimistic.

"Once this counter-trend rally has run its course, say in mid-2008, UK property shares could approximately halve in value over the following months as an economic recession drags down market rents and precipitates the insolvency of many highly leveraged investors," wrote Mr Allen.

In anticipation of the rally, the bank has also changed its price estimates for the major property stocks. For the end of June 2008, it has set a price target of 1,280p for British Land stock, up from the previous target of 910p, while Hammerson's has been set a target price of 1,130, up from 980p previously. The target for Segro, which has been changed from 410p to 590p, and Brixton, which has changed to 390p from 270p, has also been upgraded.