We like to try and spot bargains in battered sectors. They don’t come much more battered than commercial property, a sector that covers retail, industrial and office buildings and can extend to leisure, healthcare and even infrastructure, according to some fund managers.
British prices are around 35% down on where they were in 2007 (albeit the first half of this year saw only a 2% drop, according to Capital Economics) and a string of funds featuring household names, such as Standard Life and Aviva, have shut since the financial crisis struck. So could this be the perfect time to be brave just as others are fearful?
“Investors searching for income are looking again at commercial property as returns from cash and bonds continue to fall,” says Lucy Warwick-Ching in the Financial Times. A yield of around 6% (according to the IPD All Property Quarterly Index) is tempting when interest rates on a typical bank deposit are barely half that rate. Some funds, such as the Ignis Commercial Property Trust, offer yields of nearer 7.5%.
Capital gains over the past three years have also been decent, as prices have emerged from their post-crisis depths. However, there are several reasons to be cautious. The economic backdrop for businesses remains pretty dire. The International Monetary Fund has just slashed its British growth forecast for the whole year to 0.2%. In the spring, the figure was 0.8%. The Ernst & Young ITEM club has pencilled in zero GDP growth for 2012, albeit with some hope for low inflation and higher consumer spending in 2013.
One of the biggest risk factors for commercial property prices remains Europe, as Capital Economics notes. On top of a forecast 6% fall in capital values for 2012 as a whole – and no meaningful recovery until 2014 – they see a risk to rental yields too if a “disorderly” eurozone break up disrupts the London office market in particular.
Even the professionals in the market seem to agree that the outlook is gloomy. One of the best guides to the future of the market is the RICS Commercial Property Market Survey. A majority of surveyors saw demand drop off in the second quarter, despite landlords offering more letting incentives. Meanwhile, overall available space grew for the 21st quarter running. More space means higher competition for tenants and lower yields.
Overall then, although commercial property may have shown a few sparks of life recently, the immediate outlook is gloomy. We’d shop for bargains elsewhere.