Inflation seen lifting UK property investment

LONDON Wed Dec 1, 2010 1:31pm GMT

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LONDON (Reuters) - Investment volumes in prime-grade UK commercial property could get a boost in 2011, as the rental outlook for the sector warms and investors seek refuge from poor gilt returns eroded by high inflation.

UK commercial property values fell 44 percent during the 2007/09 global financial crisis, and since then a 15-month, 15 percent rebound in prices has lost steam, sparking fears the broader market may be on the cusp of a double-dip downturn.

"Prime UK property is seen as a safe haven and inflation hedge ... and overseas investors have an additional motivation in the weak pound," said Rob Mills, partner at Mountgrange Investment Management, which is investing 300 million pounds for mainly overseas institutions.

Regular inflation-linked rent reviews for many UK commercial buildings underline their value as a hedge, especially given the Bank of England (BoE) expects inflation to run ahead of its 2 percent target for at least another year.

Improving property rents in some markets -- notably central London offices -- could support or even lift total returns over gilts, property consultancy DTZ DTZ.L said.

Major government bond yields are forecast to remain constrained in 2011, while the ongoing debt crisis on the euro zone's periphery sent UK gilt yields lower this week.

"Central London should see strong rental growth for the next two years. With development finance still tight, there is less concern about oversupply for the short to mid-term," said Tony McGough, DTZ's Global Head of Forecasting & Strategy Research.

DTZ's latest Fair Value Index shows central London offices will outperform five-year gilts over the next five years, as the rental outlook stabilises, to book total returns of more than 5 percent over the period.

A potential offer approach by U.S. mall-owner Simon Property (SPG.N) last week to acquire Capital Shopping Centres CSCG.L, which owns 13 high-end malls across the UK, is viewed as another sign of rising investor interest in UK property.

"We see the events as further evidence of the strong demand for prime assets, which we believe will result in valuations surprising to the upside," said JPMorgan analyst Harm Meijer.

HEDGE BENEFITS

JPMorgan estimates Land Securities (LAND.L) and British Land (BLND.L) trade at implied net yields of 5.5-6 percent, against 3.3 percent for 10-year gilts, 2 percent for 5-year gilts, and October-year CPI inflation of 3.2 percent.

"A lot of foreign and British institutions continue to be chasing UK prime (property) stock because of a higher income return than you can get elsewhere ... particularly gilts," Ian Whittock, chief investment officer of ING Real Estate Investment Management UK (ING.AS), said.

Some analysts believe the prime property market's attraction will be further underlined if BoE leaves interest rates at their record lows, while potentially reviving an asset buying scheme to improve liquidity and encourage investments.

A stronger direct investment market would also bolster the portfolio values of property companies, such as Land Securities and British Land. Some analysts have already upgraded their sector ratings in recent months.

"We think that when it comes to property stocks, UK REITs offer better inflation protection (than those in Europe)," Morgan Stanley analyst Bart Gysens said, noting UK companies tend to have long-term fixed rate debt, while debt duration in Europe tends to be shorter.

Jones Lang LaSalle sees European property investments rising 30 percent to 130 billion euros in 2011, led by the UK, France and Germany, while a DTZ report showed the UK to be the second most favoured single country market for property investments next year, after the United States.

Whittock said UK property values would be further supported if BoE restarted its quantitative easing QE.L programme in mid 2011. "Without QE, on balance property values will be marginally down," he said, noting secondary property would be worse hit than that in prime locations.

Martin Langlands Pearse, who manages Henderson UK Property Unit Trust and expects a strong performance from prime London offices, said investors still needed to be cautious on strategy.

"Now is not the time to advocate taking a more gung-ho approach, but in this market, experienced portfolio managers will have the ability to enhance cashflows and add potential value by moving up the risk curve," he said.

(Editing by Andrew Macdonald) (See www.reutersrealestate.com for the global service for real estate professionals from Reuters)

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