By all accounts 2016 looks set to present more challenges in the commercial property market than the past few years.
Whilst 2014 and 2015 enjoyed strong capital value growth, this is now waning and investment will likely be focused on rental growth and income returns (as well as strategic value-adding in the form of refurbishments and development).
The prospect of a rise in interest rates and the uncertainty surrounding the upcoming ‘Brexit’ referendum, as well as supply issues within the capital and wider global economics, is expected to have some impact on investor behavior but most experts maintain that the property market will remain buoyant.
Here are the key issues for the year ahead in commercial property:
Income will be top priority
In the general climate of caution, established investors are mostly looking to the long-term income-producing potential of commercial property as oppose to brief, opportunistic investments.
However, whilst this will probably remain the case in London, where office space supply continues to drop (BNP Paribas reported that London office vacancies dipped to a fifteen year low in the third quarter of this year), entrepreneurial, short-cycle investors are likely to do well by shifting their gaze to regional cities and small lot sizes in all sectors, especially retail.
Mat Oakley, Director of Commercial research at Savills reports:
‘Typically the average yield on lots of £5m-£15m is 100-200bps higher than it was in 2000 and 2007, and we believe that this is a reflection of a perception that smaller lots are higher risk or lower return. We expect this margin to close in 2016, driven by opportunistic investors buying smaller lots to combine into larger portfolios for eventual sale to an institution. This end of the market also represents a rich opportunity for the private investor.’
On the whole, however, demand will rise in long-term earning potential as an asset class.
Rental market looks rosy
Given the reduced capacity for capital growth that the current climate fosters, the rental market is the obvious attraction for investors looking to make the most of the income component of commercial property.
With vacancy rates at an all time low in London, rents are continuing to rise and with insufficient plans for development, they will continue to do so throughout 2016.
Investment Director at Heartwood Investment Management, Alan Sippetts, states in IFA magazine:
‘Between 2010 and 2013 new building activity was depressed, resulting in the current low vacancy rates. The sector continues to play catch-up, especially given the extended timeframe of completion for new developments – anywhere between 12 and 24 months.’
He refers to statistics recorded by the IPD Central London Index: a 5.2% rise in London office rents in the first half of 2015 and predicts that the whole year’s growth will surpass the forecasted 8%.
As city companies struggle to keep up with the rent increases during 2016, they may well look to establish back office functions out of London to where charges are lower. This trend will buck up the rental market in regional areas.
In terms of prospects, niche office and industrial space look most attractive, whilst retail continues to be risky business due to ongoing excess supply.
Changing faces in overseas investment
Healthy rental growth and low interest rates have kept international investors sweet on the UK’s commercial property market.
Investment activity has remained energetic over the past two years and, according to The Property Investors Bulletin, half of all investment acquisitions for commercial property in the UK were made by overseas investors in the year-to-date ended August 2015.
Whilst US and Asian investors have been the most prolific, it is predicted that the economic slowdown in China will have a significant impact on inward investment this year.
James Roberts, Chief Economist at Knight Frank told WalesOnline:
‘Not only do we expect less interest from emerging market buyers, we also anticipate some selling to repatriate profits. In contrast, with the dollar strong, the market could see far more American investors in 2016.’
Despite the potential shifts in the origins of investment, the UK still remains an attractive destination for property investment: the market remains liquid and boasts a transparent and consistent legal framework that leaves those of other developed economies less enticing.
Brexit/interest rate fears could make waves
Two of the greatest perceived threats to the UK economy – a potential exit from the European Union and the prospect of increased interest rates – will be looming large in 2016 and may well have an impact on the commercial property market.
The Brexit referendum is set for 2017 and, if recent history is anything to go by, as the date approaches overseas investors may become cautious of putting their money in a precarious UK piggy bank.
Roberts explains:
‘The experience of the Scottish referendum was that some investors were put off temporarily, although others viewed it as an opportunity to bid for assets with less competition. Those in the former camp outnumbered the latter. If the polls are pointing to a close race in the referendum it will impact on demand for commercial property.’
In terms of rising interest rates, the general consensus seems to be one of calm.
Whilst the Eurozone continues to pursue quantitative easing, the UK looks likely to hike up its rates. This could lead to a ‘carry trade’ where European investors put their money in UK banks, lured by the higher interest returns.
In this case, UK banks will be more inclined to increase lending – which will, in turn, benefit the commercial property market.
Allan Sippetts gives a further context to the positive spin on interest rate rises:
‘Looming interest rate hikes would be negative in a normal cycle; but the current environment is atypical versus recent history. The interest rate tightening cycles in both the UK and the US are expected to be relatively benign and shallow, which should maintain investors’ interest in higher income assets such as property.’
If, as many predict, the Brexit referendum leads to a renegotiation of the terms of Britain’s membership of the EU, rather than a full-blown withdrawal – the two major political and economic concerns that many hold now will be assuaged.
Mobile working arrangements will continue to redefine office space
On a lighter, yet nonetheless significant note, the office spaces that fuel the engines of the commercial property market are evolving rapidly alongside shifts in working habits.
The concept of ‘agile’ work spaces was once the preserve of Google HQ and trendy Hoxton tech companies but the trend is now taking hold on a much wider scale.
Companies, both large and small, are gradually realizing the benefits of flexible and mobile working arrangements in terms of attracting and maintaining happy and motivated employees – and extending the reach of productivity beyond the office walls and the tired old 9-5.
Fixed and wired up desks are no longer a pre-requisite for every staff member and collaborative spaces are becoming a standard requirement. The efficiency savings of this move are another significant attraction to business owners.
This evolution will obviously impact the attractiveness of existing office stock and, of course, the realms of refurbishment and re-development.
And, as mobile becomes the new working norm, we may see more considerable changes in the office landscape in the years to come.
In conclusion, it seems that despite the pressures that are altering the shape of the UK commercial property market, the general outlook is favourable.
Sufficient areas of the market are able to offer steady income to investors, and that, aligned with mostly lucrative supply and demand dynamics and a stable economy, should buoy the market up.
The Savills report predicts the average return on UK commercial property investments to fall to single digits in 2016 (7.5%) but points out that this will still outperform many other asset classes.
‘As such, we expect that investor demand will remain strong, and the overall investment volume in the UK is likely to be slightly lower than the record highs of 2014 and 2015 at £60bn, but well ahead of the long-term average.’