Property’s image has strengthened in recent years after investors who had their fingers burnt in the crash started to take another look at the asset class.
Picton Capital chief executive Michael Morris is optimistic about the outlook for UK commercial property as the UK economic recovery takes hold and the sector continues to improve.
1. An improving economic backdrop is translating into strengthening confidence in the property market
Morris says: “GDP has been positive every quarter since the beginning of 2013. A low inflation environment together with rising wages and house prices has helped consumer confidence.”
2. Employment has returned to 2008 levels
Morris says: “Employment currently stands at 72.3 per cent, a level last achieved in 2008. Employment and real wages are expected to rise further over the medium term, this will boost confidence further and help rental growth gain momentum.”
3. Interest rates remain at historically low levels and rate rises are expected to be gradual
Morris says: ”Low interest rates have helped keep property yields low. When rates rise they are expected to rise gradually and so will remain supportive of property yield compression. Its also worth noting that tenant risk is likely to ease on the back of an improving economy, reducing the risk premium between gilts and property yields.”
4. Lenders have improved their balance sheets and have deleveraged a significant amount of outstanding property loans
Morris says: “Official Bank of England lending figures show that the stock of bank and building society debt in commercial property has fallen from £247bn at its peak to £177bn in December 2013. Commercial property now accounts for 9 per cent of all outstanding lending well below it’s peak of around 12 per cent. The figure of 9 per cent is also not far off it’s long run average of 8 per cent.”
5. Capital values have stabilised across all IPD property segments
Morris says: “As at February 2014, capital growth has been positive for 10 consecutive months with assets outside London showing positive capital value growth. In the quarter to December 2013, 36 of the 37 IPD segments recorded positive movements compared to 28 in September, 17 in June and 4 in March 2013.
“Confidence in the recovery in values is supported by the Lloyds commercial property confidence survey which shows 54 per cent of firms in the sector anticipate values to rise in the short term.”
6. Values outside of London are at historically low levels
Morris says: “Capital values are currently 34 per cent below their June 2007 peak. Assets outside of London are at historically low levels, with some segments still 50 per cent lower. With values in some markets still heavily discounted, the market offers opportunity to invest in assets which have not yet priced in stronger market fundamentals.”
7. Improving occupancy rates
Morris says: “The occupancy rate on the IPD Monthly Index has risen each quarter since the beginning of 2013. At the end of December 2013 the occupancy rate stood at 91.1 per cent, close to the 91.3 per cent recorded in Q4 2008.”
8. Occupier demand has returned which is leading to stronger rental growth
Morris says: ”Confidence barometers and market surveys show that occupational demand has picked up. There also seems to be a ripple effect of improving confidence and demand moving from the South East to the regions.
”The IPD Index showed that over a three month period rental growth grew by 0.6 per cent in January 2014, the last time rents grew by this amount was in December 2007.”
9. A limited construction pipeline since 2007 has led to a shortage of stock
Morris says: ”After a number of years of development cutbacks the return of occupier demand has led to an imbalance between occupier requirements and the availability of suitable space in some markets. Organisations are therefore competing for space where supply is tight, which has led to rents rising much more quickly than anticipated.
”Until there is a significant pick up in development, the shortage of supply will be a reoccurring problem for a number of years and is likely to act as a catalyst on rental growth.”
10. Commercial property is not in a bubble, market fundamentals are strong
Morris says: ”Market fundamentals are improving steadily and the number of improving markets is broadening from London to the regions. Capital values remain well below historic average levels and many properties outside of London are still well below their peak values in 2007.
”The commercial property market has benefitted from a limited construction pipeline and a rise in occupier demand. A strengthening economy will help stabilise the recovery. In addition, the tenant risk premia between property yields and gilts is likely to reduce as the economy continues to grow.”