Expert Opinion: Commercial Property – Is it too late to invest in real estate?

UK real estate shares have now outperformed the rest of the market for three years. After an exceptionally strong performance in 2014, IPD, a property index provider, reported a total return of nearly 20 percent – almost twice as much as the property sector returned the year before), investors have unsurprisingly continued to favour property funds.

The key question is whether they have joined the party too late or whether this continues to be a shrewd move.

So why has commercial property been so popular? As always it depends on demand and supply. Demand comes from the weight of money that is seeking two things – a reasonable yield and stability.

The UK, with its loose monetary policy, remains a safe haven for overseas investors at a time of global instability and its commercial property sector is relatively defensive. It is currently offering an equivalent yield of around six percent at a time when over half of Europe’s sovereign debt has negative yields and the benchmark UK 10-year gilt is now yielding around 1.5 percent. As global capital moves out of bonds and into real estate there is simply not enough real estate to go round. This pushed real estate prices further up and yields down.

Prime office buildings and industrial warehouses saw the most growth in 2014 with total returns in excess of 24 percent, while the retail property sector remained the laggard growing by less than 15 percent last year.

The Industrial sector includes logistics warehouses. This sector saw a remarkable performance in 2014 driven by the demand from retailers for “last-mile” delivery requirements accelerated by the growth of internet retailing.

This demand has been strongest in the Midlands as well as the South East and the take-up level – of newly leased amounts of space – has been phenomenal, rising by more than 70 percent from the levels seen in 2013. The supply, however, remains very low and prime quality sheds and large spaces in excess of 100,000 sq. ft. have been particularly scarce. In London the supply of industrial land has been shrinking as the pressure to build new homes has increased.

The retail sector, despite the changes in the nation’s shopping habits, has also performed well with UK shopping centres providing a total return of 14 percent in 2014, more than double the 2013 performance.

Prime yields for super-regional centres fell from 5.25 percent to four percent, helped by Land Securities setting a new benchmark valuation when it acquired a one-third share in the Bluewater centre in Kent.

Prime regionally dominant centres or those that can offer a unique shopping experience still lead the pack in terms of progressive values, but for many secondary centres the outlook is less certain. Retail as an industry is struggling with ongoing margin compression.

The prospects for high street shops differ depending on location. We remain wary of regional high streets even though they offer a pick-up in yield of around 2-3 percent, as these yields may be unsustainable.

London and the South East is still our preferred region for this year due to rental growth and developments while we also acknowledge the ongoing reallocation to the regions (but only in certain asset classes and areas).

In terms of sector selection, the supply and demand dynamics warrant another strong year for industrials, while there could also be a case made for some of the newer asset classes such as the public rental sector (PRS) and student accommodation where the long-term nature is likely to appeal to pension funds.

The pool of assets still looks inviting but just be careful which assets you dive into.