Savvy institutional investors are pulling out of the UK commercial property market in droves just as record numbers of private investors are piling in.
This difference in behaviour is striking. And it is prompting many advisers to fret that the unflagging interest of retail investors is misguided.
Some of London’s most eye-catching buildings are up for sale, including Swiss Re’s £600m cigar-shaped headquarters, nicknamed the Gherkin; the £400m Aviva Tower; and JP Morgan’s offices at Alban Gate. In the last year, some influential institutional fund managers have pared back their holdings in commercial property.
Martin Brookes, portfolio manager of the £80bn Prudential With-Profits Life Fund, reports that the portfolio has shed about £1.5bn of its commercial property holdings over the past 12 months, reducing its share in the portfolio from about 17 per cent to 15 per cent. “From a value perspective, it’s right to be selling,” Brookes says.
“What worries me is the extent to which investors have piled into commercial property over the last couple of years, largely off the back of strong past performance,” says Justin Modray of Bestinvest, the UK advisory group. “They have probably done so without understanding the asset class and may have committed a larger proportion of their portfolio than is sensible.”
The IPD UK All Property Index – a popular benchmark for performance – has returned 14 per cent in the year to date. But many analysts expect returns to fall next year to as little as 7 per cent. In April, the Royal Institute of Chartered Surveyors (RICS) predicted UK commercial property returns of 17 per cent this year and 9 per cent next.
While the soaring price of commercial property has brought stellar returns in recent years, the downside is that yields have been driven down to such lows that a further fall would discourage savvy investors even more, according to analysts.
In the past three years, average yields on commercial property in the UK have fallen from about 6.7 per cent to roughly 4.67 per cent, according to the Investment Property databank.
“[Property] yields are now at their lowest ever level recorded by Investment Property Databank and offer less than 20 basis points [0.2 of a percentage point] over the ‘risk free’ rate a 10-year government bond would offer,” a provider recently told managers at Saunderson House, the wealth management group.
Cities outside the UK now offer better value and UK investors are ploughing money into these commercial property markets, according to CB Richard Ellis, the property adviser. Yields on commercial property in Paris, Munich, Barcelona, Zurich, Frankfurt and Milan remain slightly higher than yields in London.
High prices in the UK are also causing a glut of supply. Construction of office space in London is up 80 per cent this year, according to Saunderson House, and in many cases, developers have no tenants signed up to take the additional space.
Some private wealth managers are also starting to advise their clients to reduce their commercial property holdings. “We now believe that the asset class looks unattractive on valuation grounds,” notes the latest investment bulletin from Saunderson House.
Some fund managers remain cautiously optimistic, however. In a recent note, managers at F&C wrote: “The commercial property market remains robust, but there are signs that it could be approaching its peak.... Rental growth has edged up with the improvement centred on the office market.”
Analysts say the challenge for property fund managers will be figuring out how to grow their rental income.
Yet, while returns are falling, commercial property still has one main selling point; it is a good way to balance a portfolio as returns from this asset class tend to be quite different from stock markets.
Modray suggests investors hold 10 to 15 per cent of their portfolio in commercial property. “Even if returns on commercial property fall further, they are still likely to be more than cash and in the long run, property remains a good way to diversify your portfolio,” he says.
