By Alan Sippetts
Earlier this year we highlighted our conviction in UK commercial property versus other international markets, selectively biased towards office and industrial space in London and key UK centres. This view was challenged in January and February, when disappointing volumes and values of transactions of physical property caused some commentators to take fright.
Our view was that the lower activity was seasonal noise and should be overlooked, particularly as the data was descending from the highs at the end of 2014.
Indeed, data over the next two months provided significant payback, with overall levels of activity during the first quarter of 2015 matching the strong activity of the first quarter of 2014. The second quarter has also started strongly, as volumes and transactions reached record levels in April. Seemingly, all types of institutional investors, but especially those from overseas, were unperturbed by the UK election.
Physical property in the UK is evidently in demand. Anecdotal reports of rental trends as ever focus on the hottest areas of the market, but last week’s quarterly reports from the majority of the property industry helped to confirm a broader trend. It shows that rents across many parts of London – and not just in the hot spots – accelerated, seeing 10% or more in rental growth.
Our contacts across the property industry are also seeing similar trends of rental growth in other key UK cities for quality properties. The one exception is shopping centres, where this sector has been impacted by the oversupply of non-prime space at a time when we have seen the proliferation of mobile and internet shopping, leaving retailers somewhat uncertain about space needs. We believe this is a fundamental issue for parts of retail commercial property, which in aggregate represents 40.6% of UK commercial property, and leads us to favour office and industrial units.
Are we expecting these positive trends to continue? All things considered, the short answer is yes, at least for the next year. In an environment of low interest rates, subdued inflation and modest growth, we believe that investors will continue to be attracted to commercial property’s high and growing income relative to other asset classes. Of course, much will depend on the path of global interest rates. And in this regard, rates in the US and UK rates are expected to stay lower for longer, which should be supportive of property prices.
Another distinctive factor in the UK is that unlike in previous property cycles, speculative development has been very modest. Therefore, supply constraints for office and industrial space should position UK commercial property to outperform other major international property markets over the next 12 months.
While we retain our ongoing conviction in UK commercial property, there is one important concern looming: uncertainty around the UK’s membership of the European Union. For now the outcome of such a vote is unclear, but we recognise that a negative result may have the potential to put office and industrial property values at risk. That said and for the remainder of this year, we believe that macroeconomic considerations and supply and demand factors will be a stronger determiner of UK commercial property performance rather than the EU.
That keeps us fully invested in this sector, holding exposure to well-established industry names such as Land Securities (for large, national developments), Derwent London and Schroder UK REIT for smaller, regional exposure.
Alan Sippetts is investment director at Heartwood Investment Management
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