Commercial property investment returns set to improve in 2013
Whilst 2013 economic growth is likely to remain sluggish in the UK there are signs that property returns are set to improve with a continued polarisation between the best and worst performing assets, it is claimed.
An easing in commercial real estate credit markets and the persuasive valuation case for UK commercial property should mean that prices for the market as a whole will be broadly stable in the next 12 months, in contrast to a fall of approximately 3% over 2012, according to a briefing from Legal & General Property.
Total returns are therefore likely to be dominated by income return, currently at 6%. Given the attractive level of yield, whilst sentiment is likely to remain relatively volatile, LGP sees upside risk to medium term total returns from a positive repricing of property as an asset class.
‘Three key drivers underpin our more positive outlook for 2013. First, central banks look determined to boost growth and this has fed through to our economic growth forecasts, which have been marked higher. This gradual improvement should translate into greater occupier confidence in bearing the cost of moving into modern, well located buildings. But given relatively weak growth in absolute terms, the majority of new lettings are likely to be moves from substandard, poorly-located buildings rather than outright expansion,’ said Rob Martin, director of research at LGP.
‘Second, there is evidence of an easing in commercial real estate credit markets. US and emerging market banks, insurance companies and debt funds are increasingly originating new debt capital to the sector and there has been a greater willingness amongst the UK banks to lend to commercial property in recent months. However, these positive signs must not be over played. Appetite from new lenders remains very selective and is generally focused on originating low risk loans secured against high quality assets,’ he explained.
‘Our third driver for optimism on future returns is the valuation case. The risk premium offered by investment in commercial real estate is comparatively attractive against historic averages,’ he added.
Despite these more positive signs, LGP holds a strong view that conditions will remain highly challenging for certain property sectors and asset types in the medium term. Conversely, certain parts of the market offer better than average performance potential. Delivering outperformance for investors will be a blend of good strategic positioning and diligent stock selection and asset management.
‘A number of subsectors which have been shunned by the risk adverse environment are now priced to deliver above average returns. We favour the higher yielding sections of the office and industrial markets, primarily outside of London. To ensure that assets can deliver, the focus is on those which by virtue of their specification, their local market and microlocation can find tenants through the cycle and do not depend on a robust economic recovery. Within London, opportunities to drive strong returns are set to be linked to a far greater degree to transport infrastructure improvements and particular occupier hotspots than has been the case in recent years,’ Martin pointed out.
‘By contrast, we view the prospects for many retail property sub sectors as below average, due to the challenges of e-retailing, the growing role of supermarkets in selling non food items and the relative weakness of consumer spending. One of the key barometers of success will be ensuring that rents are priced at levels that allow retailers to trade profitably. We do, however, believe that the strength of the retail market in London, benefiting as it does from the growth in international tourism, is a sustainable long term trend,’ he said.
‘We also see significant opportunities to invest in a wider spectrum of real estate assets, including student accommodation and health care. Among the advantages to these sectors is the availability of long, index-linked contracts which provide a good match for many investors’ liabilities,’ he concluded.