Chris Godding, CIO at Tilney Investment Management explains why they are neutral on commercial property.
'Since the European Union (EU) referendum, the UK commercial property market has been more resilient than initially expected. Even so, the IPD’s 2016 2.8% negative capital return was the first negative capital return since 2012 in the UK, driven by stamp duty changes and the initial reaction to the referendum.
Prior to the triggering of Article 50, the market managed to stabilise relatively quickly, as transactional evidence confirmed that property assets were being more robustly priced than previously thought – pockets of the market led by the industrial sector even saw a reacceleration in growth.
Demand for office space is typically more sensitive to the economic cycle and our expectations of total return in this sector are distinctly modest, particularly in London, where Brexit uncertainties are likely to overshadow the market for some time to come.
Meanwhile, valuations across the industrials and logistics sector have been well supported due to the lack of supply of quality assets and this helps to boost the overall portfolio returns. In retail, higher levels of debt are likely to constrain consumption and many retailers are struggling with higher wage costs. Retail also faces the long-term structural issues of online and we prefer managers who have limited exposure to this space.
Given the uncertain outlook, prime properties that deliver income protection with strong covenants will most likely be favoured.
Other than a chaotic Brexit outcome, and the related impact on UK growth, key risks to the property market would be a reduction in investment from overseas buyers, as well as a sharp and rapid rise in interest rates.
Despite these risks, we believe that careful selection of property investment managers can deliver an annualised return of between 3 and 4% and, although our expectations are lower than the long-run historic return, the low correlation to other asset classes and relatively low volatility justify a neutral allocation to property in a portfolio.
In our return expectations we currently only assume that income is source of return and discount this to account for the cash liquidity in many fund portfolios.'
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