Surging real estate returns are set to continue in 2015, with strongest growth in the regions as central London cools.

February 2015

Key points

  • Five-year all-property total return forecast raised to 9% a year, with growth slowing sharply from 18-19% in 2015.
  • Retail likely to be the only main segment to grow faster this year than last, aided by stronger consumer spending.
  • With the outlook for interest rates more benign and government bond yields close to record lows, demand for real estate will remain strong for some time.
  • Stronger growth expected in regional markets than in central London, where assets look more fully valued.

Highest returns in 26 years

The outlook for UK commercial real estate remains positive, helped by stronger domestic economic activity and a more subdued outlook for interest rates. Valuations still look attractive, despite strong capital growth driving returns at 19.3% in 2014 - the highest in 26 years.

The threat of deflation has grown following a plunge in oil prices. Meanwhile, financial markets believe monetary policy around the world will remain looser for even longer. The UK is no exception, with domestic inflation expected to dip into negative territory during the first half of 2015. This combination of deflationary pressure and loose monetary policy mean government bond yields have fallen even further - in some cases to record lows.

Good foundations for further growth

Ever lower interest rates and bond yields support property markets by providing more room for yields to fall. While real estate appears expensive in absolute terms, it continues to look attractive against other low-risk, income generating assets.

Meanwhile, the strengthening economy is helping to improve occupier markets across the UK. While uncertainty over the approaching general election may hang over markets in coming months to create bouts of volatility, the implications for real estate policy should be modest.

Offices in south-east England and London continued to drive the market higher in 2014, with an annual total return running in the high twenties

Return forecasts upgraded

As a result, we believe property returns will be even higher over the next five years than envisaged three months ago. For the 2015-2019 period, we now forecast annual all-property total returns of 9%, an increase of one percentage point. But the opportunity will not last for ever. There will be increasingly less room for yields to fall after 2015 as the rally in capital values cools.

Strong demand set to rise?

Demand from a broad range of investors, including overseas and institutional buyers, remains strong. And with credit conditions easing, demand could be set to rise. Yields are set to fall further and rental growth is on the cards, so total returns should stay buoyant. However, growth is likely to be stronger in regional markets than in central London, where assets look more fully valued.

Rental market leading the way

Offices in south-east England and London continued to drive the market higher in 2014, with an annual total return running in the high twenties. The industrial sector trailed a close second. Retail, with a mid-teens return, was the lowest of the three main segments. We do expect, however, the retail sector to be the only one of the three to perform more strongly in 2015, with cheaper oil prices set to boost consumer spending.

Summary

In general we recommend keeping a continued focus on higher-yielding market segments and secondary assets. We also see merit in taking on additional leasing risk by refurbishing regional offices to improve the quality of assets and meet growing occupier demand. While rents should recover across the UK, income growth is likely to be strongest in London and south-east England.

 

Important information:

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”) as at 1 February 2015. Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. 

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