So, will investor demand continue? All the signs suggest that the appetite by investors for bricks and mortar is likely to continue unabated for some time yet. Activity in the first quarter showed that a record £13.6bn was invested in UK commercial property, the strongest ever start to the year, and inconsistent with the potential fallout over political worries.
But property deals in April slumped by 54 per cent from March, although the latter was boosted by two big one-off deals in the student housing sub-sector. The rest of the decline reflected a drop in the value of deals in the office sector. This tends to explain the valuation drop in deals from £8.2bn in March to £3.8bn in April. Taking a look further back reveals that these gyrations have less relevance, given that the value of deals struck in April were only 4 per cent down from a year earlier.
At first glance, it could be possible to argue that industrial property yields are starting to look a little expensive. But, as Capital Economics points out; while the 26 basis points spread between industrial and retail yields is the lowest on record and far below the 15-year average of 109 bps, the spread between industrial and office yields stands at 125bps, nearly double the 15-year average. The implication here is that retail property is the odd one out. And in relation to office property, industrial property looks cheap, given that while higher office rents are now broadly in line with the longer-term trend, industrial rents are 8 per cent below their benchmark. It could also be argued that, after a period of inactivity, a stronger supply response for industrial property has acted to slow the rise in rental growth.
When it comes to the vibrant - some may argue, frothy - London office market, it could be premature to suggest that the very low level of yields in this sector is acting as a deterrent for fresh investment, because, despite continued yield compression, the hunt for assets in the Capital remains on. In fact, in the last six months London’s share in value of the number of deals that have taken place has risen from a third to nearly a half of the national total.
And that demand continues to leave the London market on a different planet to the rest of the country. The diversity of perceptions is no more clearly encapsulated than in how people define fair value. According to research by RICS, three-quarters of respondents believe that current market valuations excluding London represent fair value, a marked contrast to London where only 45 per cent of respondents believe that valuations in the Capital represent fair value. But there is a kick to this, because whereas just 4 per cent support the idea that properties outside London are overvalued, in London this number jumps to 45 per cent. Opinion polls, or more specifically polls on the election outcome, have recently been shown to be less than reliable, but if these numbers hold up, it suggests that expectations for stronger growth in secondary rather than prime office space could hold true. In fact, a common theme running through the most of the key areas outside London is that the supply of new quality office space is struggling manfully, and failing, to keep up with demand.
The situation in London is hardly any better. While demand for office space continues, availability is down 30 per cent on a year ago and is at the lowest level in over a decade. At just 1.5m sq ft of available space, the supply of new space is now back at pre-recession levels. Inevitably, City prime rents have risen 14 per cent in the last two years to an average of £62.50 per sq ft. In fact, prime rents are expected to see double digit growth for the first time since 2010. Capital growth may not maintain the stellar gains recorded in the last few years, but the scope for rental growth will be a key attraction of commercial property for investors seeking income.
