Having seen significant yield contraction since the summer of 2009, yields on prime properties now appear to be stabilising.
The market is broadening as demand for prime stock is outstripping supply, leading to an increase in appetite for good secondary property, where yields continue to firm. However, investor demand remains poor for weaker properties, where the risks of insolvencies are greater and which are likely to remain vulnerable to the economic malaise.
While we believe value can be found in UK commercial property, we anticipate that the strong rally that gained momentum in the fourth quarter of 2009 will continue to cool off as we progress through the first half of 2010. If it does not, the market may become vulnerable to a short-term correction. The rebound has been driven primarily by sentiment and relative value, rather than a material improvement in the underlying fundamentals for property. Conditions certainly remain challenging in the occupier market, where tenant demand is weak and rents are generally falling.
It is likely that investors will be looking for early signs of a recovery in the key occupier markets over the next 12 months. If economic activity continues to improve this should be reflected in higher tenant demand in 2011. Anecdotally, tenant incentives, such as rent-free periods, are already beginning to reduce. If tenant demand picks up, we would expect the rental market for prime properties to begin bottoming out before the end of 2010.
In general, we continue to favour prime and good secondary property, given its defensive qualities in a challenging market. As it is probable that the market level for rents will fall further across most sectors during 2010, albeit at a slower rate, investment opportunities will be driven primarily by stock-specific factors.
At M&G, we believe a property fund should be well diversified geographically and by sector. Our funds remain heavily overweight to prime and good secondary properties and have defensive income profiles, hence should be well-positioned both for the rebound in values and to endure anticipated weak occupier markets. As evidence of this bias towards more a defensive portfolio, the M&G Property Portfolio, for example, currently has a vacancy rate of only 4.8%, compared with 11.5% for the IPD Monthly Benchmark, and an average lease duration of 14.6 years, versus around 8.5 years for the benchmark. In addition, the recent acquisitions for the fund have added to the defensive nature of its income.
For further ideas on how to get the most from your property fund manager, visit www.mandg.co.uk/iview to view M&G's Property Masterclass videos.
For Financial Advisers only. Not for onward distribution. No other persons should rely on any information contained within this article. Source of M&G Property Portfolio statistics: M&G Statistics as at 28.02.10. Source of commercial property initial yield: IPD as at 31.03.10. Source of property vacancy rates: IPD as at 28.02.10. Source of average lease duration for property: IPD as at 31.12.09.This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The registered office is Laurence Pountney Hill, London, EC4R 0HH. Registered in England No. 90776.
