2016 Commercial Property Total Returns Set To Fall To 8.8%
Date of Article
Dec 22 2015

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• Central London offices to outperform, followed by Industrial
• Retail forecast to lag behind, but out-of-town retail parks expected to perform well
• Total returns for Rural property are expected to reach 9% on the back of steady capital growth
• Residential will see total returns of 7-8%, with higher-yielding markets outside London generally performing better

22 December 2015, Total returns for Commercial Property will amount to 8.8% in 2016, according to new research by Carter Jonas, the UK property consultancy. This contrasts with 2015 which has seen total returns of 13.4%, with offices and industrial outperforming the wider market.

With yields now at or approaching their previous peaks, investment strategy will increasingly need to focus on adding value through asset management as income will be the main driver of returns.

The forecasts reflect a relatively positive economic outlook for the UK for the next twelve months, although the prospect of higher interest rates and a degree of uncertainty surrounding the UK’s position in the EU may dampen investor sentiment.

Jeremy Gidman, Head of Investment & Asset Management, Carter Jonas, said: “The party of yield compression is largely over – yields are back to their 2007/2008 peak in most areas of the market, and we are unlikely to see yields hardening much further in 2016 due to wider economic conditions. The fact that rental growth is coming through more widely should help to sustain the investment market, although it is difficult to see the volume of transactions in 2016 matching the record level we have witnessed this year.

“Asset management will be critical in delivering outperformance next year, particularly in those sub-sectors such as multi-let Industrial, where income return has traditionally been viewed as attractive. A greater divergence in prime and secondary shopping centres is also predicted, due in part to the large number of original 25 year leases entered into in the early 1990s starting to fall in.”

The London office market remains particularly strong and is set to outperform again in 2016, although further significant yield compression is unlikely as prime yields are now lower than their previous peak. However, strong rental growth is still likely to push total returns to near double digits as availability continues to fall.

Darren Yates, Head of Research, Carter Jonas, said: “There is a growing sense that parts of Central London are expensive and growth will shift towards emerging locations such as Victoria, Battersea and Stratford, as occupiers seek more cost-effective solutions.

“Most regional city centre office markets have had a good year – especially Birmingham, Manchester and Leeds – a trend which is expected to continue into 2016. With development yet to pick up significantly and steady occupier demand across the board, next year is likely to see solid rental growth and a further, albeit marginal, hardening in yields.”

Industrial continues to grow from strength to strength, as retailers realign their distribution networks to cater for the growth in online retailing. Typically, well-located units offer a combination of relatively high yields and low rents, providing the opportunity for gains through rental and capital growth.

In the retail sector, London shows little sign of slowing, as the capital’s major shopping streets such as Bond Street and Oxford Street continue to set new benchmark rental levels. This is in part due to increasing demand for space from international retailers coming to the market. Across the wider retail arena, the out-of-town market is expected to outperform high street shops and shopping centres, with rental growth for big boxes expected to accelerate in the coming year.

In the rural sector, total returns of 9.0% are forecast, reflecting a lower and more sustainable rate of capital growth, with the income return remaining minimal at circa 1.0%. Despite this moderation, land remains a relative safe haven amongst the typically more volatile commercial and residential property sectors.

In the residential market, weak capital value growth in most parts of the country means that rental income will make up an increasing proportion of total returns. A growing number of investors are responding to this shift and focussing their attentions towards property which benefits from higher rental yields. This has resulted in increased activity in regional towns and cities benefitting from population growth. While house prices are moving upwards, growth will most likely be tempered by the April stamp duty changes and a possible interest rate rise later in the year.

Greater reliance on demand from domestic buyers in London’s housing market will lead to affordability constraints in the near-term, while the Prime Central London market is expected to see modest rental and capital value uplift. This is against a backdrop of relatively flat levels of employment and remuneration growth in the financial services sector.

Increasing interest in property such as student accommodation, healthcare, hotels and car dealerships has been seen and they are now considered mainstream rather than “alternative” asset classes. The PRS sector continues to experience exceptional growth, particularly in London, with 2015 likely to be a record year in terms of starts and completions and a buoyant 2016 in prospect.

Darren Yates, Head of Research at Carter Jonas, said, “We’re still positive about the outlook for UK property in 2016. We should see modest capital growth, driven mainly by rising rents, but returns will ease back into single digits. Activity may also cool, against a backdrop of the EU debate and the prospect of higher interest rates. It should also be remembered that, seven years after the financial crisis, the market is approaching its natural peak in the cycle.”