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04 Sep 2023

UK Commercial Property

Feature / thematic

Recent Trends and Outlook

Market Backdrop: CBRE reported flat capital values across all UK commercial property over Q2 2023. However, capital growth across the three main UK commercial property sub-sectors was mixed, with Office (-2.3%) in negative territory, but Retail (+0.7%) and Industrial (+1.2%) seeing valuation uplifts.

Investment Trust Sector Backdrop: As well as experiencing a fall in underlying asset valuations, Property investment trusts have seen an even greater share price sell-off against a backdrop of rising interest rate expectations and macroeconomic uncertainty, with the discounts of all direct property funds widening since the end of 2021.

Q2 2023 NAV Updates: At the investment trust level, LFL portfolio valuation movements over Q2 2023 ranged from -1.1% (Balanced Commercial Property Trust*) to +2.0% (Ediston Property Investment Company). Diversified UK Commercial Property investment trusts generally saw the largest valuation uplifts amongst their Industrial & Logistics and Retail Warehousing assets, and tended to see the biggest valuation declines at their Office properties.

Market Outlook: Further polarisation within sectors is predicted, with secondary rental and capital values under more pressure than prime. Active asset management should be a key advantage, as it can help to protect valuations and grow rental income. In addition, in the medium term, peaking interest rates in the UK, or even a loosening of monetary policy, will be positive for commercial property values. A common view is that the Office sector remains under structural pressure, whilst the Industrial & Logistics sector is expected to continue to benefit from structural and thematic tailwinds.

Investment Trust Outlook: The current spread between the yield offered by 10-year UK Gilts and the UK Commercial Property investment trust peer group is close to the 20-year average, suggesting that the de-rating of Property investment trusts caused by the need to adjust relative yields has now played out. Any fall in Gilt yields from the current level could act as a tailwind for share prices, while this should also prove positive for underlying asset valuations. As a result, investors may benefit from a ‘double whammy’ of rising NAVs and a tightening of discounts as and when the interest rate outlook stabilises. For diversified UK real estate exposure, we are currently recommending LXi REIT and Schroder Real Estate Investment Trust.

*Denotes a corporate broking client of Winterflood Securities