Secondary property returns in the UK will outperform prime from 2014, says DTZ
Secondary property will outperform prime on a total return basis from next year, according to a secondary market pricing update report from DTZ.
The milestone moment will be largely driven by a fall in the prime/secondary yield spread resulting from the improving economic situation and an increasing appetite for risk among investors.
The yield spread – the gap between prime and secondary yields – is set to peak this year, then narrow to near-2008 levels by 2017, which would generate stronger secondary capital growth via the yield compression. The superior income return for higher yielding secondary properties therefore means secondary is set to outperform on a total return basis.
Ben Clarke, an associate director in DTZ’s UK research team and author of the report, says: “A gradual increase in prime yields from 2015, as the current low interest rate environment returns to normal, means, despite the narrowing yield spread, secondary yields are not expected to return to pre-crisis levels. Secondary capital values in 2017 are still projected to be nearly a third below their 2006 peak.”
Although the contribution of rental growth to commercial property assets has been relatively small compared with the impact of yields, secondary rents have fallen 17.4 per cent since their peak in Q2 2009 while prime rents have been on a continuous upward trend. Going forward, secondary is forecast to unambiguously be the underperformer in terms of rental growth. However, the gap is forecast to narrow gradually as secondary rents return to positive growth by 2015 in line with stronger GDP growth.
Richard Yorke, head of UK research, says: “The overall performance of secondary property is much more sensitive to domestic GDP growth, typically it outperforms prime in periods of economic strength and underperforms in periods of weakness.
“In recent years many UK prime occupier markets have been supported by a chronic shortage of new development, whereas largely-oversupplied secondary markets have been fully exposed to the struggling domestic economy. However, with GDP projections now positive and with investors’ appetite for risk returning we will see yield spreads narrowing over a sustained period which will result in secondary assets performing better on a total return basis.”
At a sector level, secondary offices are set to continue to outperform in 2013, driven by central London. Higher-yielding secondary segments - such as industrials, and offices outside London - have greater scope for yield spread narrowing and are expected to outperform from 2015 onwards.
The ‘all property’ total return for secondary is expected to be 5.1 per cent in 2013, compared with 8.6 per cent for prime. Secondary is then forecast to accelerate to 12.1 per cent in 2014, overtaking prime at 10.1 per cent. Between 2015 and 2017, the total return for secondary is projected to remain in double-digit territory while prime is expected to be in the region of six to seven per cent.