Cluttons property outlook 11th April 2016

Cluttons’ Commercial Property Market Outlook predicts total returns for the UK commercial real estate sector will reach 6.5% in 2016, which is less than half the 13.8% return achieved in 2015 and a third of the 19.3% achieved in 2014.

Cluttons cite slowing GDP growth and Brexit fears for creating uncertainty in the commercial property investment market, which has consequently led to lower returns. Going forward, rental income growth and asset management initiatives should be the main performance drivers for the year ahead instead of yield compression.

Faisal Durrani, Cluttons Head of Research said: “The UK commercial property investment landscape is being subjected to some challenging headwinds. Chief of these is of course the risk of a Brexit and the deteriorating global outlook. The uncertainty and nervousness being fuelled by the in-out EU referendum is impacting the value of sterling and the volume of property transactions. 

“If the UK were to vote to leave the EU, property values are likely to fall. Conversely, if the UK remains in the EU, there may be a rise in the value of sterling, which could make the UK look a lot more expensive than it is now to international investors.”

John Barrett, Cluttons Head of UK valuations, added: “Although our predicted figure for returns this year is lower than recent years, it needs to be understood in context. With a current income return of 4.8%, commercial property still remains fairly priced in comparison to other markets such as 10-year gilts, which currently yield around a 1.5% - a healthy, positive yield gap of 330bps.

“This compares to the previous market peak at the end of May 2007 when 10-year gilts returned 5.28% compared to the monthly IPD income return of 5%, that is, a positive yield gap of only 28bps. This means that commercial property is in a much more robust shape to cope with any economic downturn and unlikely to crash when compared to 2007/8.”

Cluttons also argued that because the occupier markets are not over-supplied, there is still value to be had in terms of rental growth especially within the office and industrial sectors, due to limited speculative development in recent years and strong occupier demand.

Barrett added: “Future performance from direct property investments will need to come from the traditional fundamentals of rental income growth and asset management initiatives such as change of use, lease restructuring and refurbishments.

“Also, many funds are now seeking assets with secure longer term income streams as a defensive play in a market where lower returns will become the norm.”

Cluttons predicts industrial total returns in 2016 to reach 7.5%, overtaking office total returns at 6.6% in 2016. In 2015, total returns from offices (at 18.2%) exceeded industrial (17.3%).