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The future is Real

20 June 2017

Will Fulton, Manager of UK Commercial Property Trust, on what’s next for UK real estate.

After a difficult 2016, UK commercial real estate has started 2017 in a much more positive fashion. Capital values have moved back into positive territory, while rental growth has remained stable and investment activity has picked up. So, what has driven real estate’s recovery and what can we expect next?

Certainly, the second half of 2016 is a period many UK real estate investors may want to forget, as the fallout from the EU referendum hit. Market returns dipped and many investors, particularly private investors, reduced their exposure to the asset class because of a lack of clarity over the economic and political direction.

Amid this uncertainty, the UK Commercial Property Trust held up relatively well. Fourteen out of 16 lease negotiations it had in progress immediately before the EU referendum concluded on the same terms after the result. Importantly, the trust’s closed-ended structure meant that, while the share price experienced some volatility, it continued to offer liquidity throughout and this without the need to sell assets.

Having successfully weathered this storm, we are now in a position to look to the future with relative confidence. The dire economic consequences that many predicted in the aftermath of the referendum result have failed to materialise. With historically low interest rates and bond yields, investors continue to look elsewhere for income. In this environment, real estate’s elevated yield compared with most other asset classes remains a key attraction.  

The macro view from Standard Life Investments is that politics will continue to dominate headlines in 2017, economic growth is likely to be subdued, and some further inflationary pressure may be seen. Against this backdrop, current indicators suggest reasonable positive returns from UK commercial real estate in 2017.

From a sector perspective, industrial property is preferred (industrial estates and logistics warehouses). The shift by consumers towards online purchasing, which has caused a significant increase in demand for warehousing space by retail businesses, should help deliver real rental growth.

Conversely, the outlook for Central London offices is less positive. Returns from this sector were slowing pre-referendum. However, the result has brought additional uncertainty and downside risk, with businesses here most exposed to potential regulatory restrictions on European trade reducing demand for office space.

Recent activity within the trust reflects these views. Prior to the referendum, we sold two properties – Arlington Street in London’s West End, and Dolphin House, Sunbury – which reduced the trust’s exposure to London offices. The sale of 13 Great Marlborough Street, Soho, London, followed in January this year, at a yield of 3.3% and ahead of its year-end valuation.

We reinvested part of these sale proceeds in a £22.8 million forward-funding commitment to acquire an industrial distribution unit in Burton upon Trent. Due to complete in July 2017, the unit was fully pre-let and will generate a yield on cost of 5.8%.

Elsewhere, the retail sector requires careful consideration. Inflationary pressures may prove a significant headwind. This could mean more pronounced polarisation within the sector between good and bad properties (in terms of location, income length, and tenant strength).

Therefore, stock selection will be vital in delivering strong returns. During 2015 and early 2016, we reduced the trust’s exposure to the retail sector by 10% while increasing exposure to the industrial sector.

In summary, UK commercial real estate remains a strong proposition for investors despite ongoing political uncertainty. While capital growth is likely to be subdued this year, the sector’s generous income-generating ability will be the main driver of returns. As a result, the asset class is particularly appealing for those seeking a stable, regular income.

With an attractive 4.1% dividend yield (as at 19 April 2017), the UK Commercial Property Trust is well positioned in the current environment. It contains a portfolio of prime assets geared towards income generation and we remain focused on adding value through asset management initiatives.

In addition, the Trust has a strong balance sheet with low gearing and considerable financial resources available to take advantage of further investment opportunities. One to consider for those investors looking to add real estate and its many benefits to their portfolio.

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