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City buildings

Solid foundations

19 March 2015

Commercial property transactions hit record levels last year and the outlook remains positive as the UK economic recovery continues.

As confidence improves amongst Britain’s businesses, investors in the bricks and mortar of the nation’s offices, industrial units and retail premises are reaping the rewards. Last year saw another year of strong returns from the UK commercial property sector - the best since 2005. 1

Philip Gadsden of Orchard Street Investment Management, manager of the St. James’s Place Property fund, says that UK commercial property remains in heavy demand amongst many different investor groups, including UK institutional investors, international sovereign and pension fund investors, private investors and, increasingly, private equity-backed asset management specialists. 

Commercial real estate specialist, Jones Lang Lasalle, reported £65bn of transactions in the UK in 2014, the highest level on record and 3% more than was achieved in 2006 before the financial crisis.

Gadsden cites the search for yield in a near-zero interest rate environment as the driver for much of the weight of money flowing into the asset class: “whilst property yields have fallen, they still remain significantly in excess of the returns available on traditional investments like gilts. By that measure, property is still an attractive investment alternative.”

Steady stream

As the chart below illustrates, commercial property values have not been immune to significant falls during recessionary periods. However, the consistency with which commercial property has provided a stable and attractive income return, even in times of economic turmoil, is its key attribute and why it is seen as a good diversifier alongside the traditional asset classes of equities and fixed income. Figures dating back to 1986 from Investment Property Databank reveal that the average annual nominal income return has been 6.3% over the period and has never fallen below 4.3%.

Annual Returns growth and income

Source: IPD annual returns, data to 31 December 2014.

Short supply

Orchard Street reports that good quality property is becoming increasingly difficult to acquire and some investors are compromising on asset quality as they seek to deploy capital in UK markets.  As a result, secondary property has recently begun to outperform prime quality property as its previously higher yield offers more scope for capital growth.  “Our stance is that any outperformance from secondary property is likely to be relatively short-lived,” comments Gadsden. “We continue to retain a disciplined approach to investment, focussing on prime assets or those which, with some asset management to develop and enhance the properties, can become prime.”

The continued economic recovery in the UK has created the conditions for corporate expansion in office and industrial markets, although this has led to actual or potential supply shortages in some markets, particularly office and industrial units, in London and the South East and some major regional cities such as Manchester, Leeds and Birmingham.  However, Gadsden reports that this increased tenant demand is opening up asset management opportunities across the portfolio, and rental growth is starting to feed through into all markets.

Looking forward, Gadsden remains cautiously optimistic on the outlook for the sector. “We believe that the weight of money continuing to target commercial property will drive further yield reductions in 2015 as values rise. The consensus forecast for total returns for UK commercial property is for another positive year for investors.”

The opinions expressed are those of Orchard Street Investment Management LLP. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management. The information contained above, does not constitute investment advice. It is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Full advice should be taken to evaluate risk, consequences and suitability of any prospective fund or investment.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected. You may get back less than you invested.

If you invest in a fund, which holds property, you should note that this can be difficult to sell and there may have to be a delay acting up on your instructions to cash in the fund. Also, the value of property is generally a matter of a valuer's opinion rather than fact.

Equities do not have the security of capital which is characteristic of a deposit with a bank or building society.

1 Orchard Street, February 2015

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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