However, a moderating economic outlook signals a return to more ‘normal’ market conditions in 2015.
The UK as the ‘bright spot’ of Europe
Set against a struggling Eurozone, the UK - much like the US - has enjoyed healthy economic growth over the last 18 months. Both economies share two key traits; their central banks have kept the cost of money extremely low for five years, while their characteristically flexible labour markets have fuelled employment growth.
Latest leading indicators also point to a strong finish to 2014. The Purchasing Managers' Indices (PMI) for Services accelerated in November, rising from 56.2 to 58.6, indicating that UK businesses are hiring more staff to meet demand. Despite weak export markets, the manufacturing index also increased, from 53.3 to 53.5 reflecting robust domestic demand.
Gloomier in 2015, but far from gloomy
The UK economy is in rude health compared with many of its European peers, but the outlook is less sanguine for 2015. Latest forecasts from the OBR envisage modest but respectable growth in excess of 2% over the next two years, although this outlook hinges on real wage growth moving firmly into positive territory.
The Bank of England is tipping inflation to drop below 1% in the coming months as falling commodity prices and weak demand in the wider global economy are felt domestically. On the upside, however, plummeting oil prices over the past six months, though painful for North Sea oil producers, should lower fuel bills and support economic growth domestically.
The enduring question is the timing of the anticipated rise in interest rates. Given the low-inflation outlook, the current consensus is now leaning towards a first rate hike in late Summer of 2015, several months after the General Election. But, when the rise does eventually come, the Bank of England has been mindful to make clear that any increases will be slow and gradual.
Commercial property shifts from price growth to rental growth
So what does this moderating economic outlook mean for commercial property? Firstly, 2014 is set to be an outstanding year for the investment market. Yields have hardened markedly for both prime and particularly good secondary assets across the UK. On the back of strong price increases, the All Property Return is on course to hit c.20% for 2014, its strongest year since the previous market peak of 2006/07.
However, there are signs that capital growth is approaching its peak, with 2015 likely to signal a return to more ‘normal’ market conditions. IPF’s latest consensus forecast underlines this view, forecasting All Property returns of 10.8% in 2015, and capital growth of 5.4%, which is less than half 2014’s expected level.
That said, with ongoing pressure to spend among institutional investors, demand is set to remain robust. The difference will be investors’ increasing appetite for assets further up the risk curve in search of higher returns.
A combination of improved occupier confidence and limited supply is providing a recipe for rental growth across the UK and, importantly, beyond the confines of London and the South East. This is particularly true of the offices and industrial markets, but less so of retail, which continues to struggle in the face of structural changes to consumption patterns.
If 2014 is to be remembered as the year of significant yield compression, then perhaps 2015 can be regarded as the year of income generation. In general terms, secondary property should outperform prime in 2015, but investors will have to choose wisely, backing the right assets in the right markets.
Get in touch
Email me direct
REGISTER FOR UPDATES
Get the latest insight, event invites and commercial properties by email