Aviva Investors believes that 2013 will mark a turning point for the UK real estate market and that in particular secondary assets currently look cheap compared to prime assets and will drive strong medium-term performance in the UK market.
But as not all secondary sectors will benefit equally, a selective approach based on sound local knowledge is required.
Anna Rule, UK property fund manager, says: “Since 2009, while UK prime real estate assets have performed strongly, the performance of secondary assets has been weaker, with cautious investors unwilling to take on greater income risk due to the uncertain economic outlook.
“Over the next five years, we believe that higher yielding sectors will drive the market-wide improvement in the UK. Our research suggests that the premium for holding secondary real estate is at high levels by historical standards and much higher than seen before 2007. Such pricing may be appropriate for an environment in which fundamentals are deteriorating and the balance of risks is heavily weighted to the downside, as was the case in 2012. We believe however that the balance of risks has improved considerably and the economy is set to experience gradual but sustained economic improvement.
“So current pricing appears to offer compelling value and indicates that there is significant scope for yield compression in secondary sectors. Consequently we expect secondary real estate assets to generally outperform prime assets and for sectors such as industrials and offices outside London to outperform on a risk-adjusted basis over the medium term. We believe that investors should therefore be considering revising their positioning in order to benefit from a recovery in secondary assets.
“Investing in secondary markets needs to be done on a selective basis, however. Income risks remain elevated, especially in several markets which are threatened by high rates of obsolescence. We believe investors therefore need to identify assets where rental levels are sustainable over the medium term. Furthermore, deleveraging continues. Some secondary markets are particularly exposed and this will constrain their capital growth prospects.
“Although we strongly believe at looking at each opportunity on its own merit through stock selection and detailed knowledge from our sector specialist asset management team, however it is fair to say that we remain cautious about the in town high street retail sector, primarily due to the structural shift that we are witnessing in this sector such as the growth of internet retailing. We are also still positive about the South East region but believe that there are interesting regional opportunities emerging across the country.
“For investors with an acute awareness of the risks and a high level of local market knowledge, combined with effective asset management strategies, we believe there is potential for secondary real estate to deliver very attractive returns.”
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