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Investment Strategy:  Fourth Quarter – Commercial Property

  • UK Commercial Property continues its slow and steady journey upwards with the ‘bricks and mortar’ property funds returning around 4% ytd. The standout sector remains Industrials, especially well-located smaller distribution units benefitting from the e-commerce boom. The Office market continues to produce divergent returns, weak in Central London but strong in the regional markets. Retail remains weak with well-publicised troubles on the UK High Street where even the mighty John Lewis is finding it tough going.
  • Rental growth is forecast to be around 1% over 3 years, led by London and South East Industrials where growth is forecast to be 5% over this period. Weakest sectors remain (no surprise here) High Street Retail and Central London Offices, though the latter has seen a couple of positive months so far this year after declines throughout 2017.
  • In keeping with the economic cycle itself, the Commercial Property cycle feels very long in the tooth but fundamentals remain supportive. Physical supply has been constrained since 2008 in line with the old saw ‘it is the supply of credit that drives the property cycle’ as this in itself drives the physical supply. Banks have remained cautious since the big crash and leverage still remains relatively benign with LTV’s low, especially in the secondary market. Equity rather than debt financing has played a much larger part in this particular property cycle.
  • Commercial Property still looks fair value. On an absolute, historical basis the 5% IPD UK All Property yield is starting to look pretty expensive but relative to other income producing asset classes, notably bonds, it remains attractive. The spread between the yield on Commercial Property and 10 year UK Gilts has narrowed from a wide of around 4.5% in 2016 to 3.5% currently but is still historically wide with plenty of headroom. It is reliant of course on bond yields remaining low but this remains the most likely ongoing environment.
  • The forecast from the boffins at M&G for the IPD return over the next five years is grouped around 5.5% per annum, though with a dip to closer to 4% in 2019. With the income return being around 5% this implies virtually no capital growth over the period

Summary: The Commercial Property cycle has become increasingly mature and returns will likely be lower going forward, driven almost entirely by rental income rather than capital growth.

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By |2018-10-03T17:40:10+00:00October 3rd, 2018|Investment Strategy Q4|Comments Off on Commercial Property
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