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Commercial property returns forecast to improve

An easing in commercial real estate credit markets and the persuasive valuation case for UK commercial property should mean that prices for the market as a whole will be broadly stable in the next 12 months, in contrast to a fall of approximately 3% over 2012 (source: IPD Quarterly Index for all property).

Total returns are therefore likely to be dominated by income return, currently at around 6%. Given the attractive level of yield, whilst sentiment is likely to remain relatively volatile, LGP sees upside risk to medium-term total returns from a positive repricing of property as an asset class.

Martin said: "Three key drivers underpin our more positive outlook for 2013. First, central banks look determined to boost growth and this has fed through to our economic growth forecasts, which have been marked higher. This gradual improvement should translate into greater occupier confidence in bearing the cost of moving into modern, well-located buildings. But given relatively weak growth in absolute terms, the majority of new lettings are likely to be moves from substandard, poorly-located buildings rather than outright expansion.

"Second, there is evidence of an easing in commercial real estate credit markets. US and emerging market banks, insurance companies and debt funds are increasingly originating new debt capital to the sector and there has been a greater willingness amongst the UK banks to lend to commercial property in recent months. However, these positive signs must not be over played – appetite from new lenders remains very selective and is generally focused on originating low-risk loans secured against high quality assets.

"Our third driver for optimism on future returns is the valuation case. The risk premium offered by investment in commercial real estate is comparatively attractive against historic averages."

Despite these more positive signs, LGP holds a strong view that conditions will remain highly challenging for certain property sectors and asset types in the medium term. Conversely, certain parts of the market offer better than average performance potential. Delivering outperformance for investors will be a blend of good strategic positioning and diligent stock selection and asset management.

Martin said: "Opportunities exist if we look beyond the traditional ‘core’ property types of shops, offices and industrial buildings. Student accommodation and social care facilities such as care homes for example, provide long, index-linked contracts which are a particularly good match for many investors’ liabilities.

"The improving economic backdrop and signs of easing in the credit markets are taking pressure off commercial property values. We believe that the persuasive valuation case will increasingly tempt equity investors to allocate more to property. However in an economy that remains sluggish by historic standards, performance differences between sectors and locations will remain wide."

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