Reality and RealignmentFriday, January 06, 2012
The strong start for UK commercial investment property in 2011 was followed by a pull-back in the autumn. The gap widened between the performance of prime properties, let on long leases to strong covenants, and most other property.
Despite this, a small uplift in capital values for all property investments is expected to be confirmed by IPD, with a total return of around 8.5% for 2011. By comparison, the FTSE All Share Index showed a negative return of approximately 5%, whilst gilts (5 to 15 years) returned 15.5% per annum.
A Consensus Forecast, carried out by Investment Property Forum in November, predicts that 2012 will show a wide variation of returns across differing property types, the best performing assets being Central London offices followed, at some distance, by retail warehousing. Secondary regional property will bear the brunt of the downside.
The residential investment market has also seen mixed movements. Again London fared best, with increases of over 10% in the prime locations. The continued uncertainty over the future of the Euro is expected to keep residential markets flat in 2012, with some exceptions for the best postcodes in suburban markets.
Overseas investors drive out UK institutions
Central London is fast becoming the preserve of overseas owners, with over 50% of City of London offices now owned by foreign investors. As a result, UK institutions are increasingly being forced to consider prime assets in satellite locations around London and some economically strong regional hubs.
The initial flurry of activity in 2011, followed by a more cautious period, has created a supply of unsold, optimistically priced Central London and south east office stock. Inevitable price adjustments in 2012 may provide opportunities for adventurous investors.
With a continuing trend of shorter occupational leases, the informed investor in commercial property will place increasing importance on assessing the underlying occupational demand, building obsolescence and levels of over-renting, when selecting stock.
Secondary and short-let properties, with poor or unclear occupational prospects, will remain under pressure during 2012 as the market stays polarised between prime and secondary / value-add assets. However, well specified properties let to financially strong tenants for lengthy unexpired lease terms, or those in prime locations, will remain in demand.
Investors seek minimum rental uplifts
The anticipated moderation of inflation throughout 2012 (following a peak in RPI last October at 5.6%), will encourage investors to seek minimum rental uplifts, rather than those simply linked to RPI or the open market.
Steady and stable areas
Sectors likely to attract ongoing interest from institutional and other property funds seeking reliable, longer term stable, if unexciting returns for their investors include multi-let industrial property in the South East, as well as social housing and community/convenience retail.
Property companies and opportunity funds seeking double digit annual returns may have to sit on the sidelines in the first half of 2012, waiting for further price falls.
The continued uncertainty in the Euro Zone will do nothing to relax the aggressive stance of banks towards their customers. New lending to the property sector is likely to remain low, with increased pricing and modest loan to value levels. We believe the banks' hands will increasingly be tied by the rigorous tests under Basel III.
The unwillingness of many investors to commit new equity, combined with the inability of banks to originate new loans, sets the scene again for long term lenders, such as pension funds and insurance groups, to provide debt for safer deals. There will undoubtedly be a shake-out of some fund management groups, who will agree property disposal programmes to appease their banks and retain investor confidence. This will create opportunities for private equity groups.
Draft legislation on changes to Real Estate Investment Trusts (REITs) announced last month will make it easier to convert and widen the ownership types to include institutions. This should help attract money into UK commercial property, and help others reposition difficult assets. A further tweaking, to expand permitted assets to include residential and social housing REITs would certainly provide scope to release troubled loans and promote these sub sectors in the mainstream investment field.
The case for investing in commercial property on income grounds alone remains strong, relative to the very low real returns available on gilts. The UK should stand the test of a re-alignment in world-wide property trading and investment patterns, being a real asset class capable of delivering a steady income in an established and transparent marketplace. All indications are that it will retain its relative attractiveness, albeit there will be marked divergences between geographical sub-sectors and property types.