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Property News Investment Focus - Secondary ReturnsBy: Mark Sherwood, Head of Investment, Vail Williams

For the last half decade the commercial investment market has been dominated by the same factors: risk aversion and paucity of bank finance.

The effect has been to drive investors towards secure prime assets resulting in a strong market and steadily rising prices.But over the past two months there has been a switch in investor sentiment as fund managers, property companies and private investors have all started focusing on secondary assets.

Why? Because they are good value. But the question is: for how long?

The market’s recent aversion to any form of letting risk stemmed from a lack of belief in the prospects for business growth. Yet confidence in the wider economic outlook is slowly building as economic forecasters believe the UK economy grew by about 0.6 per cent in the last quarter, having grown by 0.3 per cent in the first quarter of the year.

Consensus forecasts for the UK are suggesting continued weak but sustained economic growth for the next two years, this year achieving 0.7 per cent, rising to 1.5 per cent next year.

We believe that the outlook for the commercial property investment over the next six months is positive with a number of indicators suggesting that we may have reached an inflexion point.

There has been steady pick up in the numbers of tower cranes in operation; market sentiment is generally positive; bank lending has marginally improved; and property investment activity has picked up with total investment activity this year reaching £13.9billion – compared to £13.3billion for the same period last year.

Statistics for the first quarter of 2013 also show encouraging demand for office space, with take-up rising in all the principle South East office centres. Levels are still below ten-year averages but of greater significance are the steadily falling availability figures. The Thames Valley levels of supply have recently dropped below ten-year quarterly averages and are now at their lowest point since September 2008.

As this trend continues investor confidence in the occupational market is rising and, as a consequence, there is less aversion to letting risk.

The M25 office market saw increased turnover in the first quarter of the calendar year totalling £298 million, which is broadly in line with the 10-year quarterly average. A number of UK funds and overseas are seeking high-yielding properties now, as confidence allows them to raise their investment criteria up the risk scale.

There are also a number of push factors driving investors towards secondary investments: the outlook for most other asset classes is uncertain, interest rates in the UK provide negative returns measured against inflation, and prime commercial property yields have continued to fall making them less attractive.

In contrast, secondary office investments in strong regional centres can still be bought off yields in the order of nine per cent, measured against other asset classes. Considering the returns on prime property, this represents good value.

But the level of market activity in this sector indicates that pricing is unlikely to remain at this level for long as rising demand will inevitably be reflected by competitive bidding driving up capital values and resulting in lower yields.

We also recommend secondary industrial property in strong locations where yields have already compressed but still have further to go.

On high street retail we are more cautious however; this sector is still experiencing significant changes in shopping habits and the impact of the internet remains difficult to quantify. We do see pockets of value within this sector but only in specific locations.

In summary if you’re attracted by income returns ranging from 8-10 per cent, with reasonable prospects for both capital and income growth, then the secondary office and industrial markets are worth serious consideration.

But don’t think about it for too long! 

About the author

Mark Sherwood, Head of Investment, Vail WilliamsMark Sherwood is head of Vail Williams’ investment team. He buys and sells standing investments nationwide, advising on development funding and pre sales while also providing strategic portfolio advice. He advises a wide range of clients including many of the major funds and property companies, and is also retained by a number of overseas investors and UK-based high net worth investors. In addition to his investment role, Mark also provides valuations in relation to portfolios and individual assets and development advice.


 


Features August 2013

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