The commercial property sector, like the residential housing market, saw a big drop in property values in the years following the financial crisis of 2008.
However, unlike the residential property market in many parts of the country, the commercial property sector has not recovered in value to the same degree.
Outside of London, property values for commercial property are still around 30 per cent below their 2007 peak. Most other types of asset class have recovered most of the value, if not all, that was lost following the crisis.
This provides opportunities for investors and small and medium sized enterprises (SMEs) to take advantage of buying assets that are undervalued.
Commercial property growth prospects
Experts believe the commercial property sector will be one of the fastest growing investments in 2013 and 2014, because of the low level it was at relative to other asset classes.
The Investment Property Databank Ltd (IPD) reported that commercial real estate property values went up for the seventh consecutive month in November.
IPD said the average value of stores, offices and industrial properties went up by 0.9 per cent from October and total returns, combining property values and rental income, went up by 1.5 per cent, the biggest jump since March 2010.
The expected rise in the growth of commercial property is in tandem with the improvement of the wider economy which boosts demand for offices, retail units and warehouses and makes it easier for landlords to put up rents.
What are the signs of improvement?
A number of share portfolios have increased in value in recent months, suggesting that some investors realise that the sector has been undervalued. Between May and September 2013, the value of the Standard Life Property Income Trust (SLI) rose by 20 per cent.
Because commercial property is still undervalued it means yields are appealing. According to recent figures from the IPD the sector offers a gross yield of just over six per cent, very appealing in the current low interest rate environment.
As the economy continues to improve there should be scope for income to grow as rents gradually rise.
As well as income growth and a high potential yields, it is also likely there will be further growth in the capital appreciation of commercial property.
Rental growth outside of London has started because there are less vacant properties, a low interest rate environment and finances are more readily available to residential property seekers through the Help to Buy Scheme and businesses through the Funding for Lending Scheme. This means the factors are in place for a revival in the commercial property sector.
John Baron argues in an article for the Investors Chronicle that the yield available in certain commercial property sub sectors such as industrial property reaching around eight per cent.
Another factor pointing to a revival in commercial property is that low interest rates – which the Bank of England has pledged to keep low until the unemployment rate falls from its current level of 7.6 per cent to 7.0 per cent and until there is a sustained recovery – mean returns from other investment options such as bonds and gilts are historically low, so commercial property, coming from such a subdued position in terms of value, is ripe for growth.
The attractive income growth and yields on offer have encouraged investors to look at commercial rather than residential property particularly retails units with a flat above them.
Is the improvement just in London?
So far, much of the improvement has been confined to London, but that offers even better opportunities for regions across the UK as valuations have further to appreciate.
Many property experts see the regions as the biggest area for growth. In June, Investec Wealth announced that it was moving funds from discretionary clients to hold more in UK commercial property over the next 12 months, saying that the best opportunities for growth are outside of London.
London property is in a property bubble all of its own, whether as part of the commercial or residential sector.
Property in London is going up in value faster than the rest of the country and in terms of the commercial property sector, central London office space is going up in value quickly, helped by demand from overseas investors.
However, even in London commercial property is still slightly below the values seen at the peak of the market six years ago.
What areas have the greatest potential for growth?
Figures from property value benchmarking group IPD show that since the property market peak in 2007 some cities have seen declines in the value of commercial property of over 40 per cent.
IPD found that values had fallen by 46.1 per cent in Derby, 45 per cent in Swansea and 44.4 per cent in Plymouth.
Fund values for the commercial property sector also fell sharply. The average fund in the IMA property sector fell by 50 per cent from the 2007 peak to the 2009 trough. However, 70 per cent of this loss has now been recovered. IMA property is the fifth bestselling sector since August with net retail sales of £140 million.
This still leaves the sector valued around 30 per cent lower than in 2007.
Greg Mansell, head of applied research at IPD said: “The UK’s recent economic improvement has begun to filter through into property returns, and the wait for rental growth outside of London is over – an important signal for improved tenant demand.”
In the secondary market, yields are particularly attractive and as investor appetite for risk increases analysts expect higher yielding sectors such as industrials and offices outside central London to outperform over the medium to long term.
Overall, experts believe total returns for the commercial property market could reach more than 7 per cent in 2013 and strong returns are expected to continue into 2014 with the best investment opportunities likely to be found outside of London.
What are the potential pitfalls?
It is important to research the area you plan to invest in because potential returns do vary from area to area.
Potential investors need to carefully assess the quality of the property, the tenant, lease profile and location.
If you are planning to invest in commercial property funds then, according to Danny Cox, Hargreaves Lansdown head of financial planning, it is best to avoid open-ended funds.
He said: “They once experienced a huge amount of cash flowing into them and as money came in it became difficult to restrict flows - then they started buying properties for the wrong reasons.”
How can SME’s benefit?
A recent survey by Lloyds Bank found that 76 per cent of SMEs expect activity to increase in the commercial property sector in the next three to six months.
For SME’s with investments or assets in the sector this means the value of assets will go up to the benefit of their businesses.
Its bi-annual Commercial Property Confidence Monitor, which surveys of 500 real estate professionals, puts confidence at the highest level since the survey began in 2010.
88 per cent of fund managers believe asset values will increase over the next three to six months, compared to just 10 per cent12 months ago.
Lloyds said SMEs in Scotland have provided the biggest turnaround in business confidence, at 90 per cent, ten times higher than in the corresponding period in 2012.
The South West came next with 86 per cent, followed by the North West at 77 per cent and the Midlands at 75 per cent.
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