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The UK commercial property market thrives

John Redwood, Charles Stanley’s chief global strategist, takes the temperature of the UK property market.

by
John Redwood

in Features

10.08.2018

In the second quarter of 2018 investment turnover and new lettings of London offices were above the long-term average. Tenants took on 3.4 million square feet of office space, with a notable commitment of 600,000 square feet by Facebook. Offices at 5 Broadgate sold for £1bn with a rental yield of less than 4%. Meanwhile, around the UK there is brisk demand for new industrial and warehouse space, with keen competition to invest in such units. Retail is not having such a good time, thanks to the pressures of change exerted by the rapid growth of internet shopping. Prime locations still attract tenant demand, but secondary locations are experiencing rental weakness and higher vacancy rates. There is a general feeling that some high streets have to shrink, with conversions of retail space to residential or other commercial. Various troubled shop chains are forcing rent reductions on the owners of their existing stores.

It should not be surprising that commercial property remains on the whole well bid, given the capacity of the UK economy to generate many new jobs on a regular basis. Technology businesses are expanding rapidly and need additional space. The internet rivals to the high street need distribution centres. A growing population with modest rises in income is fuelling the need for more commercial space. Some valuers have been forced to revise their gloomy predictions upwards, as they see the maintained levels of tenant demand and the continuing overseas interest in investment properties. Capital values have held up despite a backdrop of rising interest rates, whilst running income on property remains more generous than on bonds or most shares.

The Central London office market faces a downturn in new construction activity soon, following a bulge of new developments coming on stream. So far, the new space has been absorbed well by the market. 100 Bishopsgate, for example, offers 900,000 square feet of new space. It has been successful in letting most of this in good time to three large business tenants. 45% of the space in construction in the City has been pre-let. People will soon be wondering where the additional space will come from in the early years of the next decade, given the planned decline in new building.

Investors in UK commercial property can typically obtain a 4% rental yield on their investment. You can get more than that in retail, with more again in more marginal locations and properties. West End London offices are a bit below the 4% guide. Most property experts anticipate little overall capital growth from here, expecting the return to depend much more on the initial income and any future rent increases. People are understandably worried about rental and tenancy prospects for retail outside the winning centres. It is true that rising interest rates usually cause falls in property values. As the income yield on a bond investment rises when the price of bonds falls, you would expect property yields also to rise in sympathy, sending capital values down. This time no-one expects much of a rise in UK interest rates from here any time soon. The Bank of England itself is steering people to believe interest rates will rise slowly and only to much lower levels than in previous cycles. Meanwhile, investors need to factor in the drop off in new commercial property construction which is a positive for values.

The UK economy has performed well considering the monetary tightening the Bank of England is undertaking. It has curbed consumer and mortgage lending, removed special facilities for the clearing banks and put up rates. The Treasury too has sought to slow the economy with a fiscal tightening, cutting the budget deficit by collecting more in tax in recent years. Last year it went further than its own forecasts delivering a considerably lower deficit than planned. The other main advanced countries are either embarking on fiscal expansion as in the US, or continuing with loose monetary policies as in the euro-area and Japan. Despite following a different course the UK economy is generating plenty of new jobs, continuing to grow and providing an attractive location for business investment. Property is proving to be a better investment here than many professionals predicted, thanks to tenant demand and the relatively high yields.

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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