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Commercial property bounces back but sector still has dangers


Retail investor money is once again flowing back into commercial property via daily dealt bricks and mortar funds, but the sector still has potential dangers, according to Rob Pemberton, investment director at wealth manager HFM Columbus.

Pemberton says the return to better health after the catastrophic falls of around 37 per cent in the IPD UK All Property Index over a two year period has prompted some fears that the recovery in prices has been too fast and that it has not been accompanied by any improvement in the underlying economic environment.

“As the UK economy will see only anaemic growth for the next two years, tenant demand is likely to remain weak, vacancy rates are still climbing (currently around 12 per cent) and rental values could fall further. It should also be remembered that one of the drivers of property prices is the supply and demand for credit, which remains tight, and not just the supply and demand for buildings,” says Pemberton.

HFM Columbus has seen a substantial amount of new money chasing a lack of institutional quality stock and prices have risen sharply from depressed levels.

UK pension funds will be buying for yield whilst prime UK property is a preferred asset class for overseas buyers who are attracted by both the weakness of sterling and by lease structures that are better than those elsewhere in Europe.

Pemberton says that as the recovery matures, so the rate of price rises will slow considerably.

“Buyers will be choosier about the price they pay and more stock will come onto the market as the banks begin to offload their significant property portfolios at prices they no longer consider depressed,” he says.

“The asset class is underpinned on valuation terms with the yield on the IPD UK All Property Index hovering around seven per cent, which is still a healthy yield pickup of around 300bps over ten year UK gilts whilst cash yield are virtually nil. Property is an asset class which should be viewed as a long term investment and where historically the bulk of the return is from income rather than capital growth.”

Pemberton believes it is a good time to accumulate daily dealt unleveraged bricks and mortar funds which tend to track the capital return of the IPD index whilst also paying a healthy income yield. The outlook for prime property with blue chip tenants, excellent locations, long leases and strong covenants is very good.

However, Pemberton warns that there is a lot of secondary and tertiary property for which the outlook continues to be dire.

“There is also a huge divergence between let and empty properties. In our view the best opportunities will always be in ‘off market’ individually sourced vehicles where we can undertake our own extensive due diligence. We would anticipate a number of such opportunities over the next few quarters and consider that these will prove to be excellent ‘bottom of the cycle’ investments,” he adds.

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