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Commercial Property

 

Outlook

The future investment outlook
Commercial property has delivered positive returns in each one of the last 10 years. Inevitably, that raises the question of whether such performance can be maintained or whether the heightened interest in property is a signal for the informed investor to take profits and look elsewhere. There are a number of reasons for believing that property has scope to continue delivering solid returns:

 
Income yields
Property remains the highest yielding of the mainstream asset types. This has underpinned its popularity and should continue to be a beneficial factor. On a longer term view, there is the possibility that commercial property yields will fall. Property has moved from yielding little more than UK shares and about half as much as gilts in 1990 to being the highest yielder today. Both shares and gilts have seen yields fall – and hence capital values rise – as investors have reassessed their value in a low-inflation, low-return environment. Property has largely been left behind, so that today it yields more than it did at the beginning of 1990.
 
Supply and demand
Like any other market, supply and demand play crucial roles in determining commercial property values and rental levels. At present, demand for investment property is high, rental levels are growing and there is a lack of supply. This has helped to drive capital values in the buoyant retail sector, which saw values rise by 14.1% in 2004 [l]. In the same year industrial property capital values grew by 9.1% [l].

Sales of commercial property hit a record £42bn in 2004, according to a survey by Property Consultancy Lambert Smith Hampton [m].

Aside from investor enthusiasm, another driver of the supply/demand balance is the UK's famously restrictive planning laws. This has often made it difficult or impossible to expand property supply in certain sectors or areas. For example, at present only the most optimistic of developers would hope to gain planning permission for an out of town retail warehouse. Tenant demand and lack of fresh supply add to the value of such properties built before planning rules were tightened.

An interesting example of the planning effect can currently be seen in London. In the Docklands part of the city there is a more relaxed planning regime and available development space. In contrast, the lack of available space in the West End has meant that it has weathered the downturn in London office space better than the City.

Sources: [l] Investment Property Databank, [m] Financial Times.
 
Economics
The general state of the economy influences the property market. Property is often seen as lagging the economic cycle. Thus an upturn in economic activity takes a while to percolate through to the property market in the form of increased demand for space from tenants. At the other end of the cycle, there is a gap between businesses tightening their belts and demand for new space drying up.

For 2005 the Treasury's latest Budget predictions are that UK economic growth will be at 3%-3.5% – above the long-term trend – before dropping back to 2.5%- 3% in 2006 [n]. This prospective growth ought to be good for the property market as it should lead to increased tenant demand. There are already signs that in the Central London office property market, a firmer stockmarket outlook is helping to raise demand for space from the all-important financial sector.

Source: [n] HM Treasury.
 
Real Estate Investment Trusts (REITs)
The UK government has been examining and discussing the idea of creating a new investment vehicle for both commercial and residential property. The goal is to improve liquidity and provide a new long-term savings vehicle for individual investors.

In the March 2005 Budget, the government announced the introduction of Real Estate Investment Trusts (REITs), which is the name given to a successful property vehicle in the US. REITs have transformed the US property market, with most US property companies converting to the REIT structure and experiencing heavy interest from income-hungry private investors.

The UK government's latest discussion paper outlines a framework for how UK REITs would work. There are still some technical issues to be resolved, but the likelihood is that the Finance Act 2006 will contain the legislative framework for REITs.
 
Property funds qualifying for ISAs
Retail investors can still maximise the potential of commercial property through other collective investment funds such as the New Star Property Unit Trust. In the March 2005 Budget, changes were announced to the Individual Savings Account (ISA) rules which mean that, at a later date, ISAs should be able to hold property funds. ISAs are tax-efficient investment vehicles. According to the Treasury's Budget statement, the ISA rule changes should be in place 'from 6 April 2006 at the latest.'
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