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UK commercial property has been quietly doing well

John Redwood, Charles Stanley’s Chief Global Economist, looks at the relative strength of the UK commercial property market.

100 bishops gate building in progress

John Redwood

in Features


The City this year sees the completion of some large office development projects. Thereafter, the potential additional supply of City office space will fall away, as fewer developers want to commit to constructing large new buildings.

Of the new constructions, 100 Bishopsgate with 37 floors is now largely let, with Royal Bank of Canada and lawyers Freshfields taking substantial space. Another large building, 22 Bishopsgate, has started lettings with insurer Hiscox announcing plans to move in. Overall, in the City and West End there is just about one year’s supply of additional space available, with a noticeable decline in new additional space as we enter the next decade. This looks like a favourable background for investors, with little sign of capital values falling or rent levels under pressure. London remains attractive to global companies and to investors.

Last year, when China and Germany led stock markets down, investors in UK commercial property had another good result. The average return for 2018 was 7.5%, a comfortable 5% real return. The bulk of it came in the form of rental income, with the average property offering an income yield above 5%. There was bit of rental growth, so going into 2019 the all-property yield on offer is closer to 6%.

The market was sustained by strong bidding to buy industrial and warehouse property, where good rental growth was recorded. The acquisition programmes of logistics companies and on-line retailers meant there was plenty of underlying demand for warehouse buildings, whilst investors also fancied that sector and were keen to acquire more freeholds and long leaseholds in good locations. The total return on industrials was around 17%, with good capital gains. Offices produced a total return in line with the commercial property average, with modest rental growth and a small overall capital gain. Meanwhile, shop properties fell a little in value, as rents were under downwards pressure and as various store groups announced their plans to cut the number of trading outlets they could manage. The commercial property market like the share market favoured the winners from the digital revolution, switching people from shops that are suffering from changed consumer choices, to warehouses being used to meet rising on line demand for goods.

There are industry forecasts of what the future might hold. They are clustered around a longer-term 5% return, meaning that overall they do not foresee capital growth but think an investor should be able to enjoy the higher income levels available on commercial property compared to government bonds or the share index. In an investment universe starved of decent income, this may prove to be a little pessimistic, as more investors come to appreciate the high yields on commercial property and evaluate the possible shortage of good-quality property in some sections of the market. Much of it hinges on the global perceptions of London. Last year, London was the most attractive global city for inward investment into property from outside the host country. This foreign buying helped sustain and lift capital values, and helped fill some of the space available.

The continuing attractions of London will rest on keeping a good framework of law and regulation, whilst avoiding taxes higher than international norms and avoiding excess bureaucracy that law abiding people and companies come to find too intrusive. This is a relative matter, as London’s future success rests in part on how aggressive other global centres become with their offers to tempt successful companies and individuals to some other city. Outside London there has also been progress, with good developments in other large centres like Birmingham and Manchester, and some growing support for regional office investments as well as for industrials.

In the last century, when inflation was higher, we got used to a reverse yield gap, where you received more running income on a government bond than on a share and where property income was similar to bonds. Today UK property gives a superior income to shares, which in turn give a better income than bonds. So a yield gap has replaced the reverse yield gap, on the grounds that income from shares and property is riskier than the income from a government bonds. Investors also need to take into account that income on shares usually goes up as dividends rise, and income on property benefits in the UK from many upwards only rent review contracts. These features make property look good value relative to bonds and shares.

So what could go wrong? Retail property will experience falling rents whatever the leases say, as more and more shop groups cannot afford the rents. London could make mistakes with tax and regulation to deter more overseas tenants and buyers. Property investments are not easy to sell if the mood changes, so you expect better value to allow for inflexibility. Most individual investors cannot afford a commercial property let alone a decent portfolio of buildings to spread risks as each property is very expensive. That drives the smaller investor to look instead at property funds and Real Estate Investment Trusts, where other issues affect what happens to their share and unit prices.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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