Investment returns on UK commercial property are expected to peak this year with all property total returns rising to an eight-year high of 17.0%, before performance markedly tails off in the subsequent two years, in the clearest indicator yet that asset values are near peaking.
IPF’s Consensus Forecast, published this morning, reports that UK all property total returns in 2014 – comprising 10.9% capital value growth and 2.8% rental value growth – are set for the highest annual tally since 2006’s 18.1%, according to IPD’s Annual Property Digest.
West End and City offices are, once again, identified as the engine for the UK’s post-global financial crisis record high, with annual investment returns of 20.8% and 20.0%, respectively.
While these annual returns are marginally lower than the achieved returns in 2010, when West End and City offices returned 22.3% and 22.7%, respectively, the composition of these stellar 2014 returns reflect a greater proportion of total returns derived from rents.
One of the more eye-catching forecasts within this morning’s IPF’s Consensus Forecast is the double-digit rental value growth forecast within the West End – at 10.4% – the highest for the office market segment since the last UK commercial property market peak in 2007 when it was 18.7%, according to IPD.
Rental value growth for City offices is forecast to come in one percentage point lower, at 9.4%. West End offices’ 10.4% rental growth is combined with a forecasted 16.6% capital growth to deliver a projected 20.8% total return. For City offices, rental and capital growth projections of 9.4% and 15.0%, respectively, are expected to combine to deliver the sector’s 20.0% annual returns.
By comparison, in the 2010 initial upswing for West End and City offices, the driver of returns then was a much greater proportion of capital growth, reflecting inflated prices as capital chased the recovery, and only 6.8% rental growth in the City and 5.3% for West End offices.
Arguably, the indication that a much greater proportion of annual total returns for these two central London office markets is coming from rental growth, rather than capital appreciation, is a positive sign.
This is because returns are linked to underlying real estate fundamentals and an improving economy, rather than opportunistic capital driving up prices.
Furthermore, in the IPF’s subsequent forecasts for 2015 and 2016, while the pace of capital appreciation markedly declines – including an exact halving of capital value growth for both sector’s in 2015 to 8.3% and 7.5% for West End and City offices, respectively – rental value growth forecasts remain more robust.
This is, perhaps, underpinned by the limited development pipeline within core locations, suggests IPF, as well as the receding impact of strong capital inflows driving yield compression.
IPF wrote that “appetite for property investment [could] decline if it is perceived to be more expensive than other assets. Nonetheless, short-term confidence is maintained with the current 2015 average higher than three months ago (4.0%)”.
IPF’s Consensus Forecast is an average of 31 separate forecasts – comprised of 15 fund managers, 14 property advisers and two equity brokers – taken within the 11 weeks to 13 August. The forecast period captures the five-year period from 2014 through 2018.
Elsewhere, the industrial sector’s annual total returns is forecast to come in fractionally under the 20% mark – at 19.8% – just 0.8 percentage points behind all office’s combined 20.6%. For shopping centres and retail warehouse, the 2014 annual total return forecasts are 14.2% and 14.9%, respectively.
“As the UK economy continues to recover, average growth rate predictions remain positive for all years of the forecast and offices are expected to deliver above-average long-term rental growth in all but the final year of the forecast period,” wrote IPF.
“The attractiveness of central London offices to both investors and occupiers appears to be relatively unchanged in the short-term and their performance prospects may be underpinned by the limited development pipeline within core locations.”
More broadly, capital growth in industrials is forecast to be 12.8%, while shopping centres is 8.1% and retail warehouses are expected to come in at 8.8%.
The headline 17.0% annual total return forecast for 2014 is up 3.3 percentage points on IPF’s May survey, in which the annual return prediction was 13.7%. All property capital value growth forecast, of 10.9%, is up 2.2 percentage points on May’s 7.7%, while rental value growth forecasts rose 0.4% on May’s 2.4%.