Momentum remains positive
Strong performance expected in 2014 and 2015.
- Higher-yielding sectors expected to outperform.
- Secondary and regional office strategies remain appealing.
- Returns expected to moderate in 2016 as higher long-term interest rates erode attraction of real estate.
2013 was the year the UK real estate market turned with the IPD UK Monthly Property Index delivering a double-digit return for the first time in three years. We expect even stronger returns in 2014 and 2015.
The UK economic backdrop is supportive as Gross Domestic Product grew 0.8% in the first quarter, or 3.1% year-on-year. Inflation has fallen for six months in a row and has been below the Bank of England (BoE)’s 2% target for three months. After the longest decline in inflation since 1992, the BoE is in no hurry to raise interest rates.
The IPD UK Monthly Property Index returned 14% year-on-year in March, up from 12.6% in February. This was the fourteenth consecutive monthly increase. The office sector was strongest, led by central London, but the industrial sector has now almost caught up. Retail sector returns have trailed but are also now positive.
Meanwhile, investment transactions returned to more normal levels in the first quarter. Preliminary figures from Propertydata.com recorded 447 transactions worth £9.7bn. UK institutions are becoming more acquisitive while overseas investors remain the most active.
The lending environment is supporting this trend with the latest BoE Credit Conditions Survey pointing to another increase in availability of real estate finance. According to March’s survey, demand for commercial real estate debt is expected to rise sharply in coming months.
In general, real estate remains attractively priced relative to other income-producing assets. We expect capital growth to remain strong in the near term, and have slightly raised our forecast for 2014 All Property total returns to 17% from 15%.
Prospects for next year look strong too. But thereafter returns are expected to moderate as rising government bond yields erode the attractiveness of real estate. We expect the biggest impacts to be felt in central London markets, where yields recently fell to near-record lows. Higher-yielding sectors should outperform both on an absolute and risk-adjusted basis over the five-year forecast horizon.
Secondary and regional office strategies remain appealing, but market sentiment and pricing momentum have already moved a long way and deals are being struck at prices well above valuations. As a result, the window of opportunity for investors to gain from the rising market is closing rapidly. Given the expected recovery in occupier markets, we believe investing in developing existing assets may be the best way to deliver value to investors.
The additional strength we expect in the near term means we have raised our 2014-18 All Property annual average total return forecast to 8.9% from 6.5% three months ago. This is slightly above the February IPF consensus forecast of 8.2%.