Investment Strategy:  First Quarter 2020 – Commercial Property

• The significant issue for commercial property has been the liquidity problems in the daily dealt ‘bricks and mortar’ funds and subsequent suspension of dealing in the M&G Property Portfolio fund. 
• Property values were in the doldrums all of 2019 for the most obvious of reasons. The CBRE UK Monthly Index for November shows that commercial property had returned 2.2% for the previous 11 months of 2019 with a 5% rental income return but a 2.8% fall in capital values, centred on the retail sector which has seen a double-digit fall this year. Rental growth is down by 0.2% this year, again with a significant fall in rental values in the retail sector. 
• The hope is that, post-election, there is a Brexit bounce as the uncertainty is to an extent lifted and investors have a more stable environment in which to commit long-term capital. 
• The wide dispersion across sectors continues. Rental and capital values continue to fall steeply in the beleaguered retail sector, particularly for shopping centres and department stores due to a combination of tenant company voluntary arrangements and administrations, increased vacancy risk and an overall requirement for less floor space by retailers as we all did our Christmas shopping online.

• On a brighter note, the prospects remain firm for the Industrials and regional Office sector with future rental growth supported by a constrained supply pipeline, as Banks have remained cautious lenders ever since 2008 and leverage remains relatively benign with LTVs low, especially in the secondary sector. The Investment Property Forum’s consensus view on UK commercial property is that capital values in aggregate for last year and this have been heavily revised down from earlier last year with forecast falls of 3.6% in 2019 and 1.8% in 2020. 
• The commercial property cycle is very mature, fundamentals are not particularly supportive and on a historical basis, the 5% IPD UK All Property yield is fairly expensive. However, commercial property still looks good value relative to other income-producing asset classes, notably bonds. The sharp fall in long-dated Gilts means that spread between the yield on commercial property and 10-year UK Gilts is over 4.0% which is wide by historic standards. In comparison with the low yields in cities across Europe and Asia, the UK still looks good value which, together with the weakness of sterling, supports continued overseas investment into UK property.

Summary: The Commercial Property cycle has become increasingly mature and returns will likely be low to mid digit driven almost entirely by rental income rather than capital growth with the retail sector continuing to be in distress. The suspension of dealing in the M&G Property Portfolio casts a long shadow over the daily dealt ‘bricks and mortar’ funds.