Demand for UK commercial property shows no sign of abating, despite yield compression in the market....
Demand for UK commercial property shows no sign of abating, despite yield compression in the market. Recent figures from the Investment Management Association (IMA) show there was £409m worth of net inflows into property funds during August, bringing the total figure year-to-date to £2.2bn. Meanwhile, launches of new closed-ended funds by Kenmore and Resolution closed oversubscribed.
Amid this strong demand from retail investors, others are looking to reduce exposure to the asset class. Prime sights such as the Gherkin in London are up for sale and property tycoon Simon Halabi has also voiced intentions to sell his £1.8bn portfolio of properties in London. To some that indicates he is calling the top of the market. The demand is driven by strong performance - the IPD UK All Property index has returned 254% over the past decade compared to the FTSE All-Share, which has returned 110.8% over that term. The sensible desire to diversify following the bear market from 2000-2003 has also stimulated the demand for property. It is this wall of money that has led to the substantial increases in capital value.
But are investors buying at the top of the market? For some time commentators have been predicting a slowdown in the asset class, but it continues to power ahead. The IPD Monthly index recorded total returns of 4.6% over the past three months and 21.3% over the past 12 months. Forecasts continue to be upgraded. The IPF Consensus Forecast for 2006 has risen to 13.4%, up from 11.2% three months ago and 8.6% six months ago.
However, despite rental increases, yields have fallen. The income return on the IPD UK All Property index over the past year was 5.6%, down from 7.3% over the past decade. At an individual level, some property has been hit harder than others. A recent report from Jones Lang LaSalle (JLL) says the yields on some central London office properties had fallen to levels below the yield of UK gilts.
For some managers, finding good property is a struggle. The giant £3.3bn Norwich Union Property fund is sitting on nearly 20% or £600m in cash - enough to buy the Gherkin if the managers wanted to. Fund groups do not want to turn back business and are now looking to mop up this strong appetite by looking further afield. New Star has voiced intentions to launch a global property retail fund in 2007. Although most global property funds focus on the Real Estate Investment Trust (Reit) market, this will look to hold bricks and mortar and will be aimed at institutional investors. The fund is expected to have broader international investor appeal than New Star's current UK property mutual fund. Elsewhere, Norwich Union plans to launch a European property fund, similar to its UK version, by the end of the year, and Close Brothers are considering a second tranche of its Eastern European fund.
Back in the UK, in the short term the strong returns to property are unlikely to cease. In the long term, property is unlikely to crash - the yields will always provide some sort of return. However, there is bound to be a slow and gradual adjustment of pricing to more sustainable levels. It means rather than a performance play, investors should be looking to property for its diversification benefits within a portfolio.
If investors can look further afield to international areas, particularly those on lower valuations, all the better in the bid to diversify and gain good returns.
Jenne Mannion, acting editor
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