With negligible returns on bond products now the norm, investors have turned to property for stable income streams as well as the diversification bricks and mortar can offer.
The Investment Association saw its Property sector enjoy its higher ever net retail sales of £3.8bn in January but will the interest continue?
Justin Onuekwusi, fund manager at Legal & General Investment Management said the asset class was still attractive on risk/reward grounds compared with equities and bonds, which he felt were fully valued.
He sad despite the increase in capital values in London and the regions, yields were still looking attractive.
But Coutts has raised the question whether commercial property has “had its day in the sun”.
Stephen Rees, head of real estate at the Queen’s bank recently warned that with initial yields – the annualised rents expressed as a percentage of the property value – on the decline, rental growth faces greater pressure.
Positive on the asset class yet extolling the particular virtues of asset selection, he said while history suggests we may be near the bottom of the yield cycle for commercial property, given what we have witnessed in the bond markets, there may be further to fall.
Nick Sketch, senior investment director at Investec Wealth & Investment said when measured against corporate bonds – issued by the very companies that are tenants of the properties – the sector still looks good value.
But while there are expensive pockets as demand still outweighs supply, Sketch warned the high demand may not last forever.
“Investors may need to worry about what happens when a high-price property gets to a break-clause on its supposedly long-term lease – if that coincides with a market downturn, tighter terms may be demanded, and in that case the capital value may suffer a double-hit as the property is de-rated.”
Marcus Langlands Pearse, director of property at TIAA Henderson Real Estate and co-manager of the Henderson UK Property Unit Trust added that a strong level of rental growth is keeping yields down across multiple sectors.
“We had muted development since about 2008 until 2011, 2012; it was rare to see anything new across office, retail or industrial. So you had limited production but the economy continues to grow, as companies grow they add to personnel, need more capacity.
“In addition, you are seeing incentives shortening, so a five-year lease now might become a 10-year lease, or a two-year rent-free period might reduce to 18 months – that all keeps the pressure on.”
Sketch suggested more niche areas might be worth looking at, less exposed to the next cylical downturn.
“Areas like GP doctor’s surgeries, some student accommodation and distribution centres with ultra-long leases may all offer less chance of a sharp derating if the economic outlook worsens without giving up much immediate income or prospects for income growth.”
Rowan Dartington investment director Tim Cockerill currently has a 7% allocation to commercial property in his ‘balanced’ model portfolio.
He said the asset class was generally a “slow burn”, remains confident over its role as a diversifier and he remains unconcerned about falling yields.
He said the value of investing in a well-managed, well-diversified property mandate was to mitigate those pockets of inflated value.
“There are areas where it is becoming more expensive but there is still scope across the UK and other regions.”
And it’s not just a London issue; prime headline rents in Manchester are expected to reach record highs of £34 per square foot – a 10% annual increase, while office space in Bristol is expected to rise 5% this year, approaching £30 per square foot, again driven up by limited supply, according to Coutts.
Langlands Pearse notes the interest rate environment as unprecedented; with low borrowing costs, geared investors will be undoubtedly enjoying decent returns purely by circumstance, it might seem.
For ungeared funds (like Henderson’s), they may have to work a little harder and with average corporate bonds yielding around 2.2% and 10-year gilts shy of 1.8%, a fund offering a 3.5% yield looks attractive.
As he predicts a total return for the sector “somewhere in the region of 6-7%”, greedy investors should probably be careful what they wish for.
“I hope the sector returns to a normalised environment. If we start to see double-digit returns again, [even in the current environment] things will start to look overvalued, which will then require a pull back before returning again to ‘normal’ – income plus 2-3% capital growth.”
So the options look broad, but patience will become more of a virtue. For those with less of a timeframe, or unsure of their staying power, perhaps property securities might be a better bet.
