Regions outside of central London are expected to catch up with it this year, writes Muna Abu-Habsa, investment research analyst at Morningstar OBSR.
A long-awaited resurgence in UK commercial property finally came through last year. Capital values reversed in May 2013, with a small positive growth of 0.01%, having fallen for 18 consecutive months, according to IPD’s monthly index.Although a meager increase, this growth then continued to gather pace, with capital values rising 0.6% in September, overtaking income as the principal component of performance and recording the highest monthly rise since April 2010.
The IPD UK All Property index returned a solid 15.2% for the three-month period ending 30 November 2013, led by the offices and industrials sectors. Although retail has continued to lag, capital values in the retail sector rose in November for the third consecutive month after nearly two years of declines.
Offices around the UK have recently been reporting an upturn in all regions, except the South West, although this growth in UK offices has been predominantly driven by the South East market.
Boost your UK property exposure
The industrials sector has also been opening in all market segments as investors are showing a greater appetite for the attractive yields on offer, accepting assets with shorter leases with the aim of capitalising on future expected increases in rental values.
While there is much to keep investors constructive on the commercial property market, the polarisation in the valuations of prime and secondary property assets has continued to dominate returns.
The yield gap between prime and secondary assets has somewhat narrowed as investors’ appetite for higher risk secondary assets has improved, but prime holdings (typically characterised by good locations and long, secure leases) have continued to command higher premiums, buoyed by their limited supply.
However, in a recent report, DTZ noted that secondary property is expected to outperform prime on a total return basis from 2014 onwards. This is also in keeping with the views of managers of property funds that we monitor, who expect the rest of the South East and other regions to catch up with central London as the high yields available in the provinces are attracting attention, even from overseas investors who, until recently, were solely bidding on trophy assets in central London.
The ongoing upbeat newsflow from UK commercial property and the sizeable move down in gilt yields have both contributed to strong inflows into the IMA Property sector.
Although a positive development for the sector, some fund managers were struggling to find suitable investments earlier in 2013, when the market was saturated and volumes were low, leading them to hold elevated cash levels. The extent to which fund managers struggled with the high levels of cash was largely driven by the flexibility of their mandates.
Fund managers who were able to invest in REITs or equitise their cash were arguably less pressured to invest hurriedly.
Indeed, this highlights a crucial mismatch between the open-ended structure of property funds and the illiquid nature of their underlying investments.
This becomes particularly evident at times of increased inflows or outflows, which mostly correspond with turning points in the property market. In fact, direct UK property funds have, on average, struggled to outperform the IPD UK All Property index through time.
As the IPD index continues to rise, substantial cash holdings in funds – necessary to fund outflows, acquisitions and developments where applicable – have remained a drag on returns, particularly in the environment of very low interest rates in the UK. Also, the index does not account for any fees or transaction costs, which act as additional obstacles to fund returns.
Clarke replacing Balkham
'Deep-dive analysis of client behaviour'
Ways to mitigate April’s increases
The best equity income funds examined