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UK property regains favour among real estate investors as demand for income grows

The increasing attraction of property for investors can be seen in the discount movement from 32% at the end of September 2008 to 6.5% at the end of September 2011 for the Property Direct UK sector.

According to the survey by the Association of Investment Companies (AIC) income is a strong pull for this sector with yields currently averaging 6.3% but returns have been positive too, up 23% over the last three years to the end of September 2011 compared to the average investment company increase of 18%.

‘Despite heightened volatility and unprecedented uncertainty resulting from the ongoing Eurozone problems, UK commercial real estate continues to be one of the few asset classes to provide reasonable positive returns over the year to date,’ said Jason Baggaley, manager, Standard Life Investments Property Income.

Richard Kirby, manager, F&C Commercial Property Trust, believes that the property market has proved remarkably resilient in the face of slow domestic economic growth, fiscal austerity, a stalling of economic recovery overseas and the Eurozone crisis.

‘There has been two years of sustained growth following a severe downturn. The initial sharp bounce back has been replaced by a year when performance has been largely driven by income. In September 2011, the annual total return was 8.7%, of which 6.9% was attributable to income, according to the IPD Monthly Index,’ he said.

In the UK property market, London continues to outperform other regions although this difference could become less marked. ‘London has out performed the regions, helped by a stronger local economy, a more affluent population, tight new supply, its role as an international as well as a national centre and its relative resilience to public sector cutbacks,’ explained Kirby.

‘Overseas investors have been attracted to this market, with London seen as a large, mature, transparent and liquid market. This out-performance is expected to persist for the next year or so but the gap between London and the regions may narrow, particularly for City offices, given the turmoil in the financial and debt markets. Nor should prime property in regional markets be written off,’ he added.

Although the long term outlook for property is positive, investors must be prepared to weather any storms which may result from recent volatility. ‘Some weakness in pricing is anticipated over the next few months as more stock is brought to market and it is likely that the softer prices are accentuated for secondary assets in poorer locations with greater investor demand continuing for relatively low risk assets,’ said Baggaley.

‘Despite some softening in the prices for poorer quality stock, reasonable positive total returns are expected over the next few years for investors as yields compensate for any modest capital declines,’ he added.

Higher personal taxation and reduced pension contributions as well as an all time low interest rate have contributed to the growing importance of income to private investors, according to managers. They recognise the need to protect income streams and emphasise the importance of careful asset allocation in a poor macro economic environment, the survey found.

The coming year is expected to be more difficult given the economic backdrop and the downside risk implicit in the Eurozone crisis but there are positive elements, according to Kirby.

‘Low interest and borrowing rates coupled with a second round of quantitative easing may offer support. The UK may be seen as a safe haven from the troubles of the Eurozone. Looking to the longer term, years of low development have led to areas of tight supply where a turnaround could be quick once demand recovers,’ he said.

‘For now though, the focus needs to be on the protection of the income stream and securing its longevity. There are differences within the market and this will involve selecting and managing property at the asset specific level,’ he added.

Annabel Brodie-Smith, communications director at the AIC said that the survey shows that property is regaining its place as a mainstay of a well diversified portfolio. ‘The closed ended structure of investment companies is particularly suitable for this type of illiquid asset and the majority of the sector has bounced back following the property bubble of 2008/9. Property is once more in demand for its ability to provide investors with attractive levels of income,’ she said.