By SIMON MOORE 05/11/2010
After 2 years of continual decline the market has now seen 14 consecutive months of growth. Although values are up nearly 20% off their bottom seen in 2009 they are still 1/3 below the peak reached in 2007. The monthly rate of capital growth, whilst improving (0.2% in September 2010), is only marginal and does not change our opinion that the UK will be flat for the rest of 2010 and probably for the whole of 2011 too.
The poor economic outlook has lead to falling rents, increasing vacancies and tenants going out of business. Combine this with the fact that lending banks are sitting on property portfolios, where the values have fallen below the loans made against them, and the outlook does look dim indeed.
In such a climate of weak capital growth the income return becomes the main component of total return. The gap between income earned on property and gilts is 4%. This is historically very wide suggesting that investors are cautious on the outlook, and not willing to take the risk without significant returns.
Commercial property investment is split into three main areas, we give our views on each:
Offices
Central London offices are starting to see rents and values rising. Outside of the capital we expect little growth and are concerned that values will fall.
Retail
High street shops have been hit hard by the recession and rental rates were down 2.1% in September alone. In our view this remains the sector with the poorest outlook, given the continuing trend in moving to out-of-town retail coupled with falling consumer spending. Conditions are worse in the North with vacancies of up to 30%, whilst Central London and the South East are showing stabilisation or improvement. For retail we prefer Central London & the South East and avoid the North.
Industrial
The worst sector continues to be Industrials where capital values and rental incomes are falling.
Conclusion
We remain positive on UK commercial real estate. The best sector is Central London offices. For the UK as a whole capital growth will be subdued for the next 1-2 years, but income return should be around 5% per annum. Property yields are still attractive compared to other asset classes and given that interest rates are likely to stay low for some time.
Alternatives to open-ended property funds
There are positive alternatives to property OEICs. For example large, liquid listed property companies, run with entrepreneurial flair, strong income profile and where there are asset management opportunities. We also like some sector specialist (eg out-of-town retail, doctors’ surgeries), REITs and infrastructure funds – but these are not often in OEIC form instead these tend to be listed investment companies.
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