M&G Property has eye on regional rental growth

And while property returns have been dominated by London, she says that positive sentiment spread outwards from central London during 2013, so that now most areas of the UK market are now seeing rents stabilise or begin to grow.

"We expect this trend to strengthen, underpinned by a continued lack of supply, particularly at the prime end, and improving occupier demand," she says. "Investors who had previously been focusing on prime property in central London are already looking elsewhere. This may be geographically, out in the south east and, to a lesser extent, the regions, or, in quality terms, by looking at good secondary or even secondary property with the potential for enhanced returns through asset management. This is already causing yield spreads on secondary and regional property to narrow, after some years at unusually high levels relative to prime. This trend is likely to continue, and even intensify, this year, suggesting that the UK property market could record returns well into the double digits."

In 2013 the IPD UK Annual Property Index made 10.7 per cent.

The commercial property sector on which Ms Rowley is most optimistic is offices, due to the strength of the labour market. "As rising confidence improves demand, occupiers, especially those with near-term lease events, are becoming increasingly aware of the supply and demand imbalance building in the market," she says. "Completions in the sector have been running at roughly half their historic annual average for the past four years. This is expected to boost prime rents over 2014 and also start to affect non-prime property as overall vacancy rates continue to decline."

But in this sector central London is likely to continue being the area that does best, with rental growth expected to accelerate over 2014 to 2015. There is a risk that over the medium term speculative development or refurbishment might dampen growth. "Nevertheless, fringe locations undergoing regeneration, driven by significant infrastructure developments, are likely to see stronger growth," says Ms Rowley. "I want to be in central London but you have to be discerning."

And outside London, the south-east office market should still see above-inflation rental growth. "Although still lagging, the regional office markets are forecast to return to rental growth after four years of decline," she says. "Recovery, however, is likely to be less entrenched further from the larger metropolitan areas."

Over 2013, the fund made a number of purchases totalling £635m, and a lot of this was accounted for by good secondary, which Ms Rowley believes is better value than prime. Taking shopping centres as an example, she says that while on average prime ones yield around 5.25 per cent, good secondary ones offer 7.15 per cent.

Shopping centres accounted for £89m of last year's purchases, while offices accounted for £309m, the fund's largest sector accounting for nearly a third of assets. Ms Rowley focused her purchases on those areas that she believes will be the strongest performers, buying good secondary offices in Edinburgh, Leeds, on London's Southbank and in the south east, for example. She also acquired a number of retail parks and a shopping centre, and increased exposure to the industrial sector with distribution centres.

As a result of the purchases the fund has a relatively low allocation to cash of 8.9 per cent.

Ms Rowley is not so confident on the retail sector, where she expects the weakest growth. "Retailers continue to rationalise their store portfolios, meaning that vacancy rates are continuing to rise on high streets across the country," she explains. "As a result, we expect to see further rental declines in the short term. Even so, there are huge disparities between the best and worst areas of the retail landscape."

Central London, for example, remains strongly supported by international demand.

"This enthusiasm is unlikely to change in the short term and therefore we expect to see rental levels continuing to rise at a robust rate," she says. "Away from London, however, rental growth will probably vary by market. The traditionally popular high streets appear to have better rental growth prospects, particularly on the prime side, supported by consumers with higher disposable incomes. Meanwhile, other areas, with weaker underlying consumer demand and greater competition from other retail formats, are likely to lag and may even see rental levels slide further."

But she anticipates moderate rental growth this year in the shopping centre and retail warehouse sectors.

Source: Morningstar, *M&G.

Performance

Source: Morningstar as at 11 April 2014

Top ten holdings as at as at 28 February 2014

Sector breakdown net of cash