THERE has certainly been a lot going on in the UK property market over the last 12 months, particularly in the final quarter of 2009. We believe that now is the right time to take a closer look again at commercial property holdings within our portfolios.
Industry data suggest that the market is starting to recover, with capital values rising. For example, in November 2009 we saw growth of 2.4%, the largest monthly increase in 15 years (source IPD).
The price correction has been driven by factors such as attractive leases and the low value of sterling, which have made the UK property market particularly attractive to overseas buyers. Many UK funds are now starting to see cash inflows increasing, which can only be a good sign.
While we are now more positive about the property sector, we believe that investment return over the next 12 months will effectively come from rental yield rather than capital growth. As a result, it is important to carefully select property funds, investing in those that hold property with long leases rather than short.
Year of two halves
Last year was widely labelled as a year of two halves for the UK commercial property market, and we expect 2010 to display similar characteristics. By that we mean the first half of the year could look very different to the second half.
We expect the first six months to be characterised by strong positive revisions to capital values, driven by limited supply and strong demand. Then, as economic activity improves, we should see some stabilisation in the occupier market and rents start to grow again.
This will be seen by many that the fundamentals will reassert themselves in the UK commercial property sector and income (i.e. rent) will resume its place as the main driver of total returns.
Since the global market correction began in 2007, commercial property rents have fallen sharply in some sectors. Landlords were forced to offer increasingly large incentive packages in order to secure tenants and reduce vacancy rates.
Break clauses and extended rentfree periods became the norm, particularly in central London.
However, this year, through the combination of strong demand and a constrained property development pipeline, we expect to see an eventual reduction in incentive packages. There is already early evidence of this happening in the office market in central London, where incentive packages have moved back to more reasonable terms.
Incentive packages
This is a sector that looks poised to recover sooner than others, as occupiers with larger space requirements move swiftly to take advantage of the space still available and the incentive packages currently in place before they are pared back.
This won’t necessarily feed into immediate improvements in rents, but it is indicative of an improving occupier market. Agents are now forecasting West End rents growing from the third quarter onwards, and growth in rents in the City from quarter four.
Tenants are also taking encouragement from an improving economic outlook. As the UK economy slowly moves out of recession, tenants who had put expansion or relocation plans on hold during the downturn are now feeling confident. Such tenants now see this as an opportune time to move and/or increase their space requirements.
It is widely acknowledged by leasing agents that rents have probably bottomed in the London office market, so tenants are realising that it may be better to move sooner before rents begin to rise again. So the London office sector will certainly start to see improvements this year.
The outlook is more challenging for the retail and industrial sectors, however. As problems with the consumer linger during 2010 and possibly into next year, we expect limited growth in rents in these two sectors.
In summary, we expect to see an improving tenant market this year, meaning that a key focus for us will be to look at the fund managers who are seeking to improve void levels within their funds whilst looking to maintain good tenant relationships and capitalise on the opportunities we see emerging through the cycle.
As always, we would only advocate investing in commercial property funds as part of an overall asset allocation strategy which is consistent with an investor’s appetite for risk.
However, such funds are far more appealing now than they were 12 months ago and this sector once again looks attractive as part of a wellbalanced portfolio.
- The author can be contacted at: Allchurch Bailey Wealth, 93 High Street, Evesham, Worcs. WR11 4DU; telephone 01386 442597, e-mail andrew.neale@abwealth.co.uk; website www.abwealth.co.uk.
