_Ask the Expert: Should I invest in commercial property?

With uncertainty from Brexit and financial market volatility on the horizon – you may be wondering if commercial property remains an asset class worth investing in.

Well, I can confidently tell you – yes, it is. UK real estate remains as attractive as ever to investors and is predicted to turnover £55bn this year. Significant volumes of both national and international capital continue to target commercial property with a particular emphasis on the UK regions. 

The in-house view is that commercial property as an asset class could return 7% this year, outperforming competing asset classes. What’s fundamental to achieving the best returns, however, is understanding and predicting sector performance which will, in turn, drive yield compression and capital growth.  

So, if we accept that commercial property is a worthy investment, which sectors should be targeted and which should be avoided?

Regional Offices

Demand for office stock remains active. Returns are easing for pockets of the market, but there is still potential for yield compression beyond Central London and towards the regions. This is supported by improved occupational demand and a lack of new build alternatives on the horizon, improving income growth for existing assets.

UK regional yields continue to outperform the rest of Europe which is why a new wave of international money from the likes of South Korea, Japan, Singapore and South Africa is targeting UK commercial property. 

Critically, evolving working practices will have implications for office investors. Accelerated by technological progress, tenants are changing the way they want to use office space. So, in the longer term, office investors will need to understand the potential impact of these changes on returns. 

There is still significant demand for office investment, the only underlying issue at present is the lack of available stock.

Industrial

Should you ignore the industrial sector as it becomes overheated? 

Despite easing returns, industrial is still set to outperform. Stock remains scarce, particularly in the North East, and competition is strong so further yield compression could be seen. This is all supported by continued occupier demand which remains healthy.

Yields have reached historic lows on the strength of competition, but this is an area of the market in which we see further potential for further yield compression for the best quality stock.

Along with regional offices, industrial property remains top of the shopping list for many domestic institutions, but they face stiff competition from private equity and specialist real estate investment trusts (REITs). 

Ongoing scope for rental growth will stand out in the context of the wider real estate market.

A lack of stock, combined with evolving retailer demand, is supporting the strong rental expectations used to underwrite aggressive pricing. Longer term, landlords will increasingly need to consider the potential implications of trade disruption following the UK’s departure from the EU.

Retail

The retail sector is clearly troubled at the moment. 2018 has seen a mixture of high-profile insolvencies, profit warnings and emergency cash injections amongst retail businesses. 

However, headlines generated by these events have obscured other retail news, including ongoing sales growth (1.1% year on year in February), stronger trading updates, and expansion plans.

We predict that a greater sense of caution will increase the availability of investment property in this market and provide good opportunities for those able to take a forensic approach to stock selection.

Retail yields remain higher than those for offices or industrial, meaning retail remains attractive to a specific dynamic of investor focusing more closely on income return.

Prime assets will ultimately offer the best long-term prospects. In the short term, however, there is potential for income volatility as tenants exert their influence to get the best deal from landlords. Non-prime propositions remain riskier at a time when tenants have the upper hand in negotiations, although in some cases this can be mitigated by a strong alternative use value, or simply the residual value of the land. 

Specialist Sectors

27% of all UK commercial property investment is now in specialist sectors and by that, we mean, hotels, healthcare, student property, private rented sector and automotive.

Over £4bn was invested in specialist sectors in the first quarter of 2018. This is a greater volume to that seen in the office sector, and more than industrial and retail investment combined.

The variety of ways to derive long term, inflation-linked income from specialist property gives the sector particular relevance in the current market, in which fewer long-term commercial property leases are being signed. 

Where investors are seeking a safe haven for capital, the specialist sector is a top priority which means yields are still under downward pressure. 

In conclusion

In a world of higher volatility and lower returns, with the right advice, commercial property should still be seen as a priority for any investors’ mixed asset portfolio.

Regional centres, such as the North East, continue to offer compelling returns for international, national and regional investors. The key is local advice to drive stock selection and drive performance. 

Dougie Cranston can be contacted at douglas.cranston@knightfrank.com 0191 594 5023.   

About the Author

Douglas Cranston is a Partner in Knight Frank Newcastle’s Capital Markets team and has been a dedicated investment agent for over 10 years. He advises a wide range of clients including international investors, UK pension funds, property companies and private individuals on the acquisition and disposal of commercial property investments. He specialises in the North East market and advises across all sectors.