There has been a lot of talk in recent months about a looming commercial property crash and horror story headlines like “London bubble set to burst” but, in reality, these scaremongering tales are unfounded and premature.
Commercial property investment continues to be one of the safe havens for investor cash and the latest report from CoStar, a leading commercial property research organisation, shows that the appetite for these assets continues to grow.
The UK Commercial Property Investment Review Q2 2015 shows that we are on track for another record year of property investment and both the capital and the regions are continuing to be hugely attractive destinations for investors both at home and overseas.
In this latest blog I consider some of the findings of the CoStar report and consider what lies ahead.
There’s some fantastic insights in this video from CoStar, but perhaps the most important message is by founding partner of GM Real Estate Tony McCurley who says the UK is “on everyone’s shopping list”.
London remains the top global city for investment while the whole of the UK was the most active investment market in the world after the US over the past 12 months. We’ve seen another phenomenal year with £73.6bn poured into commercial property and it isn’t showing any signs of slowing down.
We saw a total of £16.8bn invested in the UK in Q2 of this year, which was up 8% on the previous year, and £6.5bn of that money came from foreign investors, an incredible 44% increase on 2014.
Despite fears that falling yields in an overheated London market had seen it pass its peak, the research showed that the capital bounced back with investment surging 61% quarter-on-quarter and attracted £8.7bn in investment, up 46% on last year.
The UK regions also remain a hugely popular destination for investors as they continue to deliver the best yields and rental growth. For example, investment in the North East was up by 131% on the five-year quarterly average, with £308m invested in commercial property.
The UK remains one of the most attractive investment destinations for a number of reasons. The main reason is the continuing strength of the economy and its fast growth. However, traditional draws like the market transparency and political stability have always provided a high degree of comfort for investors.
When you couple this with the potential for further growth in the regions and the continuing strength of the capital, it makes the UK an obvious choice.
Another major factor is the continuing instability around the globe. With the neverending woes in the Eurozone, conflict across the Middle East and Russia and China’s economies in turmoil, investors inevitably are looking to find safe havens for their money and the UK is proving to be a solid bet.
The report also shows its good news across the individual investment sectors. The office sector surged ahead in Q2, accounting for almost half of all investment. The strongest performers were London and the South East but I expect the regions to get stronger over the course of the year as we’re continuing to see a rise in demand and a number of new developments are now finally coming through the pipeline.
This rising demand coupled with a lack of available office space is also turning into optimism for developers and that will also see the return of speculative projects in the months to come.
Again industrial was a top performer and that is reflected across the country. The only blip was a drop in retail investment – which fell to its weakest level in two years – but that will recover in the second half of the year due to a number of major centres due to come to the market.
Yield compression also resumed strongly, reversing the brief upward movement we saw in Q1. The average all property yield compressed to a five-year low of 6.88% as yields fell in all sectors. With furious competition continuing in London, office yields also sank to a new low of 4.2.
In my own opinion, property investment will remain to be a safe bet. As I said at the start, the likelihood of the bubble bursting is slim. While London is seeing a significant slowdown, I believe that’s just a sign that the capital is now stabilising and the regions still have plenty of room for growth.
This growth and soaring occupier demand will fuel confidence for investors and developers alike and we’ll see a raft of new speculative development in both the office and industrial sectors in the regions. There’s also still a huge weight of money looking for a home and that will deliver robust trading in the months ahead.
Yes, there are still some draconian elements to the market that dampen spirits a little – the threat of empty rates still continues to frighten developers – but that will only stall values briefly while everyone catches up.
The threat of an interest rate rise also still looms large on the horizon, but any increase will be very slow as the Bank of England looks to nurture the growth in the economy.
There’s been much talk of the impact of a Brexit – Britain leaving the EU – and even though this is unlikely, it will have little impact on property as it’s rarely heavily affected by short-term politics.
Couple all this with the continuing instability in a number of economies and nations around the world and the UK will continue to remain on every investors shopping list.
Cushman and Wakefield’s latest Quarterly Marketbeat report paints a promising picture for UK commercial property investment and shows, as many suspected, that the market has continued to strengthen into 2015.
Healthy business and consumer confidence is delivering the fastest rising occupier demand in almost 20 years and that is applying upward pressure on rents across all sectors.
The biggest riser, unsurprisingly, was the office sector which saw rents soar by 6% over the year while industrial climbed 3.9% and retail 3.2%.
The overriding theme of the investment market is the continuing lack of available stock and that hasn’t been helped by people waiting to see the outcome of the recent General Election. However, the weight of demand and high prices being fueled by intense competition is motivating many to now consider selling.
Activity is also being boosted by the resurgence of the financing market, with banks and other financial institutions once again actively looking for opportunities to lend to across a range of sectors and markets.
Retail is perhaps the biggest surprise of 2015 so far. Prime high street assets in key market towns and major regional hubs have become a top target for UK funds and institutions and overseas private equity as they still offer good prospects for capital and rental growth.
Cushman and Wakefield’s research shows that the rising consumer confidence and solid occupational performances seen in recent months have dramatically improved investor appetite and, while the South East remains the most popular destination, key regional hubs like Birmingham, Leeds and Edinburgh are being considered in the hunt for solid capital and rental growth.
Shopping centre demand also remains high and we are now also seeing a lot of private equity buyers looking at the secondary market and the larger lots.
The top performer this year will be the office sector and that will be primarily driven by rental growth due to the lack of stock. Well-located and good quality secondary stock along with offices with redevelopment potential will see the strongest demand from investors.
In the regions, there is still room for further rental growth and yield compression due to strengthening fundamentals. Well-located and good quality property in the secondary market is also expected to remain attractive due to the potential for capital growth.
Another top target for investors in the office sector will be properties with potential for redevelopment or asset management opportunities in the areas of high occupier demand.
A lack of space will also be the driving factor in the industrial sector and investment appetite will remain strong. The growing demands of occupiers, with internet retailers at the front of that queue, will deliver strong rental growth. ,.
For investors, opportunities are starting to come through from landlords keen to sell assets acquired within the last 3- 5 years, where they can realise profit already. Many have also started speculative development, buoyed by growing demand from occupiers.
Perhaps one of the most interesting aspects in the report is the predictions for rental growth and average prime yields around the country for the next 10 years. It throws out some encouraging news for investors, but also has some surprises.
Looking across the UK and the regions in the north are in the best position for delivering rental growth. In the North, North West and Yorkshire and the Humber, investors can expect to see average rental growth of around 5% in retail over the next 10 years, 5.4% in the office market and 4.2% in industrial.
When considering average prime yields, the same three regions are strong performers again and have seen little in the way of compression over the past 12 months when compared to the rest of the country.
Perhaps most surprising though is that Cushman & Wakefield recently predicted that the South West will see little or no growth in each sector over the next ten years because the market has become so overinflated.
The fast-approaching pension reforms which will allow people to draw cash from their pension fund and spend it how they see fit are causing some concerns. Many fear people will take advantage of these new regulations and tax incentives to draw down billions of pounds from poor-performing pensions and then spend that cash unwisely.
Deciding how best to invest your pension money can be a minefield, but many will be looking to put that money into property.
Property is performing well and we have seen unprecedented amounts of cash invested in commercial property over the past 12 months because of huge double-digit annual returns. The residential property market is seeing decent growth and that will also be attractive to savers who are being held back by meagre interest rates with no prospect of increase.
However, individual property investment does have one major drawback. It can be very difficult to unlock that cash when you need it the most and, if you don’t have the experience and insights needed for property investment, it can be a lottery.
Alternatively, syndicated property investment can be a sound bet for people looking to invest their pension elsewhere. Not only does it give you access to a wider pool of properties, but the choice of which property to invest in is entirely yours rather than handing control of your investment to a discretionary property manager. Each purchase is thorough researched with all the necessary due diligence being made available for investors to review and form their own opinion. Here I’ve listed five reasons why you should consider investing your pension in a syndicated property fund.
1. Spreading the risk of your pension investment
By joining a syndicate you can invest your money in multiple properties, which helps to spread any potential risk of tenant default which is one of the main risks with any commercial property investment. The minimum investment is £25,000 and that means you can choose to invest your pension cash in a wide variety of different properties. There is no maximum, but typically people invest around £150,000.
As an added bonus, each property is independently managed, valued and the legal title to the property should also be held in the name of an independent Professional Custodian Trustee, ensuring that the property is protected even if the investment manager ceases to exist.
2. You can sell or transfer your share in the property at any time
With individual property investment, your pension money will be tied up in the property until you can sell it. At best, that means a two month wait for your money should you need it. In reality, you will probably have to wait at least a year to sell the property and get your pension fund cash back.
With syndicated property, an investor can sell at any point and the syndicate as a whole can also decide to sell the property with a 75 per cent majority vote.
Typically, in our case, a holding is sold to another syndicate member or another member of Rougemont’s qualifying High Net Worth client base.
Ideally, syndicated property is a five-year investment, but should you wish to sell, a typical syndicate sale takes just three weeks and Rougemont as the operator of each syndicated property is authorised to assist with this role.
3. Average annual returns of 6-7 per cent on your pension money
With interest rates having been anchored at 0.5 per cent for years and the threat of a further cut now on the cards, savers have been heavily punished during the recession. As a result, most are now looking to take control and find the best returns they can for their pension fund.
Syndicated property investment delivers average returns of around 6-7 per cent and Rougemont Estates is delivering better returns than that.
Each investor receives a quarterly income from the property and also benefits from any potential growth in value of the building.
Total returns on commercial property last year hit 19 per cent and, while it’s unlikely to be as high again this year, investors will still be able to expect double-digit returns when factoring in both income and capital growth, providing they invest in the right property.
4. Syndicated property returns are tax free and offer long-term growth for pension savers
Around half of all investors in syndicated property are using cash from their pension funds as any income or capital gain from the property into their pension is tax free, which is obviously a real benefit.
A typical investor is 45-years-old and is seeking a secure, long-term income that offers the prospect of medium to long-term capital growth. Depending on their age and profile, we find most investors simply don’t want the hassle of playing the equity market every day or having ownership of a single property where all their ‘eggs are in one basket’ and they have to actively manage the property.
5. Pension investors get expert insight and guidance
Perhaps the biggest benefit of investing your pension money in a syndicated property investment is the knowledge that you are getting expert advice and quality investment prospects.
Rougemont Estates minimises risk in this sort of investment by drawing on their years of knowledge and buys properties in prime locations that offer strong prospects for growth through lease renegotiation or property conversion. Rougemont offer the opportunity to it’s High Net Worth audience by way of a detailed investment prospectus. The decision of whether to invest is then up to each investor. Rougemont does not have discretion on any investors funds.
We aim to buy bullet-proof assets. There is still a significant lack of quality stock out there and investors have to be careful.
However, we are confident. We look to operate in a niche area, picking up properties that are too expensive for individual investors but that are too small for the big institutional funds.
By turning to a syndicated property investment company, you can invest in properties in prime locations that benefit from long leases or offer strong prospects for lease renegotiation, rental growth or conversion to an alternative use.
For pension savers, we feel there are some real areas of opportunity within the prime and secondary market where they will be able to benefit from acquiring quality assets that present a real opportunity for growing their cash for the future.
Welcome to the first Investment Insight from Rougemont Estates. Through these updates we aim to provide an overview of the property investment market, pulling together data and research from a range of leading organisations and sharing our insights. Please note that this information collated and illustrated does not constitute investment advice and the views expressed are purely those of the Directors of Rougemont Estates.
These regular updates aim to help you develop your own strategy for investment and will deliver clear independent research on what you can expect from the commercial property market in the months ahead.
Throughout this Insight document we have provide URL links to the source of our commentary.
Investor appetite growing
Our first look at the commercial property investment market is all good news. This year has been about recovery from a long and painful recession and investors have flooded back into the market, looking to cash in on quality assets that deliver substantial yields.
Knight Frank’s latest market update shows the total investment volume for 2014 hit £3.1bn by the end of Q3 – the highest total for six years. That insatiable investor appetite is being fuelled by a strengthening economy and a strong outlook that is helping to boost the optimism of business leaders across the country.
The huge pool of capital from overseas investors and major funds here in the UK shows no signs of subsiding and the only thing holding back the avalanche of cash is the dwindling supply of quality stock.
2014 has seen all of these funds looking to the regions for quality deals and that, coupled with businesses returning to expansion mode, is delivering strong rental growth and the tightening of occupier rental incentives – all good news for existing landlords.
Property yields are stable
Dwindling supply has seen yields continuing to fall over the summer and hence prices rise. Cushman and Wakefield’s latest research shows that prime is down 7bp to 5.1% and secondary is down 17bp to 7.8%. However, gilt yields have also fallen in the past quarter meaning property’s advantage over bonds has edged up once more, ensuring commercial property investment continues to be one of the most attractive options for investors.
Savills research shows that yields are stable, meaning we are close to the bottom of the yield cycle, and yields will remain close to the historic lows into 2015. The same research shows that the all property return for 2015 will be 12%.
Couple this with the recent volatility in the equity markets, it is understandable that property continues to be a realistic and popular choice for investors.
Alternative investments
The appetite for quality stock has once again started to see the return of speculative development in almost every region of the UK, but the majority of these new developments will take two years to complete. What that means is investors are now turning to secondary markets or alternative property investments like healthcare, hotels and renewables.
JLL’s alternative property survey revealed that 90% of investors are planning to increase their exposure to alternative property sectors, while 9% will increase their allocation for alternative investments from 23% to 32% over the next five years.
What this means is investors will have to work harder to find solid returns and many are looking to the regions where they hope to find well-located stock with the potential for active asset management.
At Rougemont we minimise risk by buying properties in prime locations that benefit from long leases or offer strong prospects for lease renegotiation, rental growth or conversion to an alternative use. This strategy continues to deliver average annual income returns of 6.5-7 per cent, plus all the potential for capital growth. In 2015 we feel there will still be areas of opportunity within the prime and secondary market where our clients will be able to benefit from acquiring quality assets that present real opportunity. However, due to an increase in competition clients may have to become more realistic on their annual return expectation in order to capitalise on secure medium term growth prospects.
Rental growth will continue
Looking ahead into 2015 we believe it will be more of the same. We will continue to see growing occupier demand and that will fuel further investment demand. Rents will continue to grow throughout the year – Savills predicts five years of rental growth. This will no doubt see an increase in investors risk profiles and we are already seeing acquisitions being undertaken that factor in considerable hope value.
While vendors may be getting a little ahead of reality in terms of pricing, the pricing in the regions should stay stable for the next six months. However, opportunities will still continue to emerge from the distressed banking sector as values improve and bank managers become increasingly under pressure to return the default loans they have been managing over the last 5 years.
Perhaps the biggest question mark for 2015 will be the General Election, but I believe it will have little impact on the commercial property investment market.
The recent Scottish Referendum failed to derail the market and, historically, elections have had little impact on investor appetite. Indeed, the stable nature of British politics has long been a draw for overseas investors.
While the liquidity of direct property ownership can sometimes be seen as a drawback, it can also be a strength. Unlike other liquid assets, property does not react quickly to opinion polls or political instability and, because our major political parties are so similar, the election will have little impact, regardless of the outcome.
Overall, competition will continue to be fierce in 2015 and I also expect to see the Institutional Funds playing a bigger role next year as investors deploy further funds in property.. The outlook is good for existing landlords and likely to be competitive for new investors but opportunities will present themselves.
After four years of hardship across the commercial property sector, investors could be forgiven for fleeing in droves from a “cyclical industry” that seems to have a flat tyre. Values have flatlined, tenants are going bust or demanding cut-price rental deals and yields have soared.
It makes for bleak reading, but there is hope on the horizon. Look no further than Liberal Democrat peer Lord Oakeshott who has decided to buy back the property investment company he sold for £10m in 2000.
After selling OLIM Property, the businessman has continued to grow the fund for the Close Brothers Group and today it stands at £146m – up from around £8m in 2000. His decision to buy back the property business is a vote of confidence for the future of alternative investment and demonstrates his belief that he can continue to secure substantial returns from the sector.
In an article for Property Week, Lord Oakeshott outlines the hardships facing the sector but says falling interest rates herald a new dawn for commercial property investors.
In the article, Oakeshott says the previous years have been “a battle between high yields, which are juicier by far than those from equities and bonds, and falling rents.” He adds that investors are also being hit by tenants who are looking to downsize or are just going bust.
Oakeshott also hits out at valuers, arguing they are getting the market wrong. He says they are “there or thereabouts” on yields, but are still overpricing rents. Quite rightly, the peer says that competition in the market at the minute is fierce and every lease renewal or new letting turns into a cocktail of incentives and bargain-basement rent deals.
The property industry is cyclical and we are currently seeing good quality property becoming more scarce – which will help to start drive a recovery. However, lease lengths are shrinking and that is impacting values.
Rental rates lag the economy and Oakeshott claims that we need to see economic growth of around 1.5 per cent a year to stay level in real terms. In the current climate the prospect of empty rates is painful, so landlords are letting at competitive rents rather than holding out for historic headline figures.
That means falling rental values are here to stay for the next 12 months at least unless the economy suddenly rockets back to three per cent growth. However, as Oakeshott adds: “With the banks still
not lending to small business and the credit squeeze getting worse, don’t hold your breath!”
The good news is that inflation is creeping back to the Bank of England target of two per cent and that will stop the squeeze on incomes while also highlighting the benefits of safe property investment.
Lord Oakeshott concludes that if you believe “happy days will be here again soon” there are some exciting opportunities out there. However, he adds that “if, like me, you believe the road to recovery will be long, hard and slow, and have more dips and bumps along the way, then play it safe, stick to solid tenants and realistic rents.”
The reality is that the right property with a decent lease and a tenant with strong covenants is still a safe investment in the current climate. Even without any real rental growth, property will still deliver a decent yield and an initial return of 6 or 7 per cent.
Property prices may yet fall further but with a good location, solid tenants and sensible rents this sort of alternative investment is still an attractive option. As Oakeshott says: “You might well even make some money.”