The commercial property market has rallied alongside the UK economic recovery, and fund manager Orchard Street Investment Management believes there is more good news to come.
The UK commercial property market has moved from strength to strength this year, with the revival of the sector reflecting the positive developments for the wider UK economy. Investors continue to be drawn to the stable income available from property, but, with the market back in boom, interest continues to shift from popular areas, such as central London, to areas outside the traditional ‘safe haven’ for investors.
The attraction of the commercial property sector is in part due to the low-level of yields from bonds, which has accentuated the return available from the property market. Although the gap between the yield from commercial property and 10-year UK gilts has reduced from previous highs, the relatively low returns from government bonds still makes commercial property an attractive income proposition. John Humberstone, a partner with fund manager Orchard Street, points out that commercial property is still yielding around 5-6%.
Another positive is that a lot more deals are being transacted with equity rather than debt, with capital coming from a wide variety of sources. Humberstone says this is a far cry from the pre-financial crisis market when buyers were borrowing up to 90% of the value of a property. The events of 2008 provided the most recent demonstration of the perils of over-exposure to this asset class, and Humberstone is keen to stress the role of commercial property as a diversifier within a portfolio.
But it is the emergence of the UK this year as the fastest growing western world economy that has underpinned this renewed confidence. Quality central London offices and industrial locations in the South-East have continued to perform strongly in this environment, while economic confidence has stimulated rental growth beyond London and the rest of the UK. Moreover, the paucity of new developments over the last eight years has also pushed up rental yields.
The strong market outlook has prompted the Investment Property Forum (IPF) to forecast gross annual returns over the next four years of 9%. However, the London-based real estate analysts believe that this growth between now and 2018 will come in two phases. The next two years are expected to display a strong level of growth as capital continues to move into the commercial property market, while the following couple of years could see a flattening off of that growth. “It doesn’t feel like we are at the top of the market, but the next two or three years may see markets start to reach an upper range,” adds Humberstone.
The expansion of the St. James’s Place Property funds, which Orchard Street took over three years ago, has reflected this growing confidence in the commercial property market and wider UK economy. The mandate has doubled to £1.6 billion since 2011 and, so far in 2014, Orchard Street has made acquisitions valued at £233 million and disposals of £57 million. Further investment is expected in the final months of 2014, which is usually a strong quarter for market activity.
There have been a number of high profile acquisitions outside central London in these market conditions, notably the Richmond Riverside complex in south-west London for £64.5 million. Orchard Street has also purchased the Woolley Edge service station on the M1 near Wakefield for £35.1 million.
“It’s not glamorous but offers a secure index-linked income stream of around £2.5 million per annum for the next 11 years,” explains Humberstone. “Planning permission for new service stations is exceptionally hard to obtain.”
Debenhams’ flagship store in central Leeds was also picked up in August for £38 million, offering a 5.58% net initial yield.
The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James's Place.