Sentiment amongst property investors improves rapidly

Total returns from West End offices could also hit 18.8% this year, fuelled by rising demand for prime London space. Nationally, offices were predicted to offer total returns of 17.9%, with industrials at 15.4% and standard retail at 12.1%. The five year estimated total return for all property was estimated at 7.4% (of which 2.4% is capital growth). This compares with UK Gilts five year yield at 1.27%, according to Bloomberg.

Although many fund managers have exited the capital to invest into the regional markets, attracted by healthier yields, strong interest has persisted from foreign investors. Many see London as a safe haven and this has caused prices to soar and yields – a measure of value divided by rent – to compress.

Regional offices and industrial property typically offers higher yields thanks largely to lower prices and a lag in regional economic recovery. Industrial property was predicted to show a capital value increase of 9.4% this year, fuelled by demand from online retailers such as Amazon and manufacturers.

Although Britain’s improving economy has enabled rents to increase, the pace of rent growth was expected to dip sharply after 2016, which IPF said would partly impact capital appreciation, although the prospects for further yield compression are more likely to act as a brake on price growth. Some contributors to the research expected the EU referendum to have a substantial but short-lived negative impact on returns, but this view was not widely shared.

Despite an annual retail sales rising by 4.2% in the year to July, retail property performance continued to drag the market. IPF said weak sentiment previously expressed by forecasters had remained constant although there are some signs of improvement ahead.

Rental growth: retail to bounce back in 2016

Rental growth projections for industrial property and UK offices rose to 3.8% and 7.8% for 2015 against an all property average of 3.8%. Standard retail was estimated at 2.2% while retail warehouses showed estimated rental growth of 1.0% and shopping centres just 0.6%.

Rental growth was expected to decline for offices and industrials during 2016, but improve for all types of retail property.

Income and volatility

The office sector has been widely shown to the most volatile real estate asset class. As the table below shows, capital growth in the sector accounts for nearly three quarters of the total return, with income making up just 27.4%. Although retail warehouses have a much lower overall return, income makes up a far greater proportion of the return at 57.7%.

Over a five-year period, the medium term average proportion of income from the total return is around 68%, which underlines the short term volatility of offices.

Pam Craddock, Research Director at the IPF said: “There has been a marked uplift in sentiment, particularly towards London offices, in recent months, which underlines the strong fundamentals of UK real estate. Clearly, market volatility has hit many different asset classes recently and at such times, real assets traditionally perform well.”

Respondents predict that Britain’s underlining recovery could further bolster retail property, which has so far lagged behind other sectors. With wages now rising, consumer spending increasing and recovery spreading out, retail property is the only sector predicted to show increased rental growth next year.”
 
Phil Clark, Head of Property Investment at Kames Capital, said: “Pricing in London’s office market means there is little headroom left for investors. However, for those bringing stock to the market over the next year, the outlook will be positive. Considerable scope exists for adding value in many under-served regional locations, and this has propelled a growing number of transactions across regional office and industrial properties.”
 
Mike Keogh, Associate Director of Research & Strategy, TH Real Estate, commented: “The upgrade to UK real estate performance projections comes during a period of renewed global economic and political uncertainty, which has reiterated the strong yield-driven attractiveness of commercial property.

Present real estate market momentum should persist into 2016, unless there is a blip in the economic recovery, as the return of rental growth should be sufficient to offset relative pricing concerns linked to a now-delayed normalisation of interest rates.”
 
Lee Sheldon, partner and co-head of real estate at Addleshaw Goddard, said: “These data underline the ongoing strength of UK real estate, particularly in the face of economic headwinds in the global economy. Low interest rates typically create a favourable context for real estate investment and in spite of predicted interest rate rises, the medium term outlook remains positive.

The surge of City offices over the near term reflects the typical volatility of the asset class and major portfolios across South East are coming to the market. However, a lack of new stock on the market has suppressed supply and kept rents high. As ever, timing is key, and some of the UK’s largest REITs have timed their pipelines just right to benefit from offices’ strong performance.”