External Insight - CCLA - Property Sector Perspective

Monday 06 February 2017   Category: Economic Updates

This is an Insight written by an external organisation. The following article was written by CCLA and represents their views.

The sector began 2016 brightly, with strong cash inflows from domestic and international investors expecting another year of rising rental values.  The positive early momentum however was not maintained, slowed initially by a growing focus on the Referendum and finally stopped by a surprise 1% increase in Stamp Duty, which had an immediate and negative effect on valuations.  The unexpected outcome of the Referendum had a sharp impact on the sector, although more on sentiment than on values.  In the uncertain environment transaction volumes fell away and without activity to support them, valuers became cautious.  Against this backcloth attempts by a small number of investors to redeem their holdings achieved little beyond some unhelpful headlines.  As time passed so gradually it became clear that, although the sector had been adversely impacted, the reality was less dramatic than feared.  Transaction volumes slowly recovered and capital values, which had been marked lower in late summer, rose again.

Inevitably there were some important differences in returns at the sub-sector level.  Industrial assets gave the best returns, a reflexion of low historic supply and strong demand, particularly from the logistics sector.  Offices improved, although progress paused in parts of London but the ugly duckling was retail, where long term changes in shopping patterns, excess current supply and concerns about the sustainability of rents created an environment of investor caution.  These trends were reflected in the changes in rental values.  Industrials improved by nearly 4%, in contrast the gain in retail was just 0.8%, all generated in London and the South East. 

Looking forward into the year ahead reveals some clear positives for the sector, but some challenges too.  Income will be an important support.  Property is the highest yielding of the major asset classes and the income advantage is likely to increase due to rental growth.  In an uncertain investment environment a high yield provides a robust buffer against the risks of near term fluctuations in capital values.  The economic background should be helpful too.  Growth will continue and although the expansion will be at a lower rate than that achieved in 2016, the link of an expanding economy and rental growth is a strong one. In addition, continued currency weakness will ensure UK property remains an attractive asset choice in an international context.

Once again sub – sector trends will be important. Offices should continue to make progress, particularly in the stronger regional centres, but an exception to this positive overall trend will be out - of - town office parks which remain deeply out of favour.  Some will be rescued by conversion to residential use but more will see further erosion of income from weak rents and rising void rates.  Increased uncertainty will boost demand for long term income assets specifically because of the income assurance they provide.  Supermarkets have been poor performers in recent years and they are one of the areas which will benefit from this trend, particularly now that yields have risen to more competitive levels.  The key question mark of course is over trends in London; the capital accounts for about half total UK turnover by value.  The supply news is generally good.  There is no current excess of capacity and this cycle has not experienced the surge in speculative supply that has been the cause of problems in the past.  Demand however must be much less certain whilst the implications of ‘Brexit’ remain unknown.  One comfort is that City of London valuations are not over - extended, on a simple price basis the West End is more exposed.

What does this mean for investment returns?  Income looks both secure and attractive.  Less certain are the prospects for capital values where the range of forecasts  has remained wide, despite the steadier trend of recent months. Our expectation is that returns will be positive but to a modest extent compared with the strong gains seen in recent years. As is always the case with property, sub- sector allocation and asset choice will be key influences on the performance achieved.

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