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Commercial Property Outlook

Capital Growth and a Decent Income

Commercial Property Outlook

Commercial property has had a good run over the last three years or so, experiencing considerable capital growth, with a decent income. As widely expected going into the year, returns are more muted and yields have normalised.

Enthusiasm for commercial property as an asset class has suffered from negative sentiment, driven by concerns in the first six months of the year of the effect of a potential Brexit on the domestic economy, combined with global economic growth worries. The introduction in March of the new tiered system of stamp duty rates on commercial property purchases affecting those investing in larger commercial property can also be factored in.

Income growth drives returns

Prior to the referendum Ainslie McLennan co-manager of the Henderson UK Property PAIF, expected the three-to-five year story for commercial property to be dominated by income, with improving occupier demand leading to some considerable rental growth in some parts of the market.

Andrew Friend, Fund Director of the Henderson UK Property OEIC, concurred that the high capital returns previously experienced will not be sustained and that there is a clear transition toward income led returns. From a sector perspective he remains underweight high street retail, based on structural change in the sector, instead preferring retail warehousing as an alternative.

Retail continues to lag

Recent figures from the IPD (Investment Property Databank) showed that the UK Monthly Property Index returned 0.6% to 31 May 2016. Total returns from the three main areas of retail, office and industrial commercial property were 7.1%, 12.6% and 13.7% respectively over a 12 month rolling period to the end of May; retail continues to lag, no doubt inhibited by the rise in popularity of online shopping. Although there are wide regional variations with central London retail favoured.  

Post-Brexit Outlook

Although it’s too early to fully gauge the effect of Brexit on commercial property transactions and valuations, because the process for exiting the EU is a long one, markets are likely to remain uncertain for a protracted period of time. What we do know is that the Bank of England has warned that commercial property is a key risk to the economy following the vote; they have already conducted stress tests on banks to ensure they can withstand a 30% fall in commercial property prices.

UK commercial property had already come under pressure in the run-up to the vote. According to Investment Association statistics, the IA UK Property sector endured £500m (net) in outflows in April and May. Since the vote, the level of redemptions from UK commercial property funds has accelerated, resulting in several fund suspensions. The illiquid nature of bricks and mortar meant it was impossible for the level of redemptions to be sustained. Investors will now need to wait for a specified period of time for the suspensions to be reassessed.

The Financial Policy Committee has warned that these suspensions could cause difficulties in the wider economy as businesses struggle to access finance against their commercial property assets.

On a more positive note, Sterling’s decline may well act as a stimulus and encourage foreign investors enticed by cheaper property purchases.