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Property returns down by two thirds as low economic confidence drags down values

UK commercial property total returns fell to 2.7 per cent in 2012, down from 7.8 per cent in 2011, caused by falling capital values across the regions.

Values fell by 3.1 per cent for the year, while income returns held up at six per cent, according to the IPD UK Quarterly Property Index.

Negative valuer sentiment drove the fall in values, as UK property underwent its most challenging year since the downturn and the economy slipped briefly back into recession.

Steady income returns will bring some relief to investors, who have maintained cash flows despite muted occupier demand (rents remained flat for the year). Income continues to make property an attractive investment medium for investors, amidst the volatility of equities and low yields off gilts.

Beneath the headline figures, the divergence in prices between London and the rest of the UK continued to grow. Over 2012, values in Central London rose by five per cent, but fell by 5.8 per cent outside of the Capital.

This polarisation in property prices has now reached unprecedented levels: since June 2009 the divergence has widened to over 35 per cent between Central London and the rest of the UK. 

However, pricing for prime assets in the capital has driven income yields down to just 4.3 per cent for retail and office assets, as competition from “safe haven” international investors makes investment expensive.

Though the focus of investors has shifted increasingly to income producing characteristics - utilising better value, more fringe or secondary assets, with secure leases and potential for active management – for the moment there has still been little indication of improvement in the majority of regional or secondary sectors.

For the first time, new prime/secondary lease analysis has demonstrated the attraction of “quality” secondary sector stock.

Four asset types were measured in the study: long leased prime, short leased prime, long leased secondary and short leased secondary properties.

Since 2009, the best performing asset type has been long leased prime. However, consecutively over the last four years, long leased secondary stock has delivered higher returns than prime assets with short leases – due to a combination of strong income returns and more competitive pricing.

In 2012 secondary long leased assets returned 3.6 per cent, opposed to 4.1 for prime long lease, and 2.7 for prime short lease.

However, while secondary long leased property is based on a 6.4 per cent initial yield, with no reversionary uplift, prime short leased assets offer stronger income growth prospects, with a current reversionary yield of 7.8 per cent – despite an initial yield of a little over five per cent.

Phil Tily, IPD UK and Ireland managing director, says: “Property is dividing the UK as London returns and the regions lose value. The sector is also split between those with capital holds and others seeking income. Different investors have defined for themselves different objectives, and that is one of the beauties of real estate: its flexibility.

“However, there’s no getting away from the bleak outlook these figures paint for some sectors. Commercial space is a key indicator of economic performance, so it’s of little surprise to see regions faltering amid growing retail trauma and continued job cuts.

“But 2012 also delivered the first good news for parts of the secondary market, and the question for 2013 is whether it will be a more level playing field over the next year. What we do know is that those funds performing the best over 2013 will focus very much on asset management – which is where the transparency of the UK sector really matters.”

Launched alongside the Quarterly Index, IPD’s 2012 benchmark figures - which measure the performance of fund types across the year, and include the effects of transactions and developments - showed large life and pension funds to be the best performing fund type in 2012, returning 3.1 per cent, against the benchmark total return of 2.8 per cent.

The worst performing fund type was balanced monthly funds, which returned 1.5 per cent.

High London exposures drove outperformance, contributing two per cent of the 2.8 per cent benchmark total return, with the remaining 80 bps delivered by assets in the South East – while returns from the rest of the UK were flat.

When fund performance was split into quartiles, the spread in returns was considerably larger, with the top 25 per cent of funds returning 6.5 per cent, and the bottom quarter -3.9 per cent. The best performing funds had an exposure to Central London of over 35 per cent, while the worst only 9.8 per cent.

Malcolm Hunt, IPD UK and Ireland director of client services, says: “London owners are taking advantage of continuing international demand and selling carefully selected assets to strategically boost their returns. Assets sold in Central London over 2012 delivered a return to investors of, on average 25 per cent.

“But without the effects of London, the market remains difficult, and regional declines are impacting on returns. However, it is worth noting that over the last five years, 95 per cent of portfolios measured have still delivered an average income return in excess of five per cent.”

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