With growth in total real estate transactions likely to level off in 2016, commercial property investors are adopting a more targeted approach, focusing their attention on prime offices and industrial in UK cities which are at an earlier stage of the recovery cycle.
Investment in UK commercial real estate totaled £71m at the end of 2015, an indication of the strength of the UK market in recent years.
It is inevitable, therefore, that we are now at the later stage of the market cycle and that growth in total transaction volumes is now likely to level off, argues Charu Lahiri, investment manager at Heartwood Investment Management in a recent opinion piece.
However, Lahiri expects transaction volumes to stay around 2015 levels for this year and while she predicts lower yields, increased dependence on rental growth to drive returns and diminishing asset class relative value, she also states that opportunities aplenty exist for the motivated investor.
Prime offices and industrials are held up as examples of assets to target, with the retail sector seen in a less positive light, due to the troubles faced by high street commerce.
It is the geographic bias of recent investment trends that is all set to change though, says Lahiri.
Slowly London and the South East may cease to have the monopoly over commercial property investment, while businesses such as Heartwood Investment Management report seeing more opportunity in other UK cities, which are at an earlier stage of the recovery cycle and offer greater capital growth and higher rental yields.
The Central London office sector is still considered a robust market, where demand continues to outstrip supply. Although rental growth may slow, a fall in yield is not expected.
What has been observed is increasing investor confidence outside of London, particularly from overseas.
Lahiri notes that foreign investment has long been a key driver of London/prime real estate markets, hitting a plateau of around 70% of the central London market in 2014/15.
This may continue during 2016 but international investors are increasingly turning to cities like Manchester, Birmingham, Bristol and Leeds on their global hunt for yield.
“In 2015, around 35% of transactions outside of London involved foreign buyers compared with the historical average around 15%- 20%. Here again, though, selectivity is key as there is broad dispersion. For example, the take-up of offices in Aberdeen was down 50% relative to 2014, due to the city’s dependence on the oil sector,”
Lahiri highlights the fact that both prime and secondary property yield spreads remain high relative to 10-year UK conventional gilts and UK corporate bonds versus their historical averages. As such her recommendation is that UK commercial property should represent a core part of a multi-asset investment portfolio.
Lahiri believes that the concerns surrounding the UK economic outlook are all headwinds.
Reduced export activity, slower business investment and the anxiety linked to the upcoming Brexit referendum should be counter balanced, she says, by solid levels of occupier demand.
“UK commercial property remains a core allocation within our portfolios. However, following strong performance in recent years, we are looking to reduce some of our allocation to more volatile, equity-like instruments, such as developers, which have a higher exposure to retail, as well as London and the south east. Our preference is to have a targeted exposure to those sectors that we believe are best positioned for growth – prime offices, industrials and select opportunities in regional UK cities,”
For the latest research and analysis into mortgage transaction data for Vanilla Buy to Let, Houses in Multiple Occupation (HMO), Multi-unit Freehold Blocks (MUFB) and Semi-Commercial Property (SCP) see the Mortgages for Business Complex Buy to Let Index Q1 2016.