Commercial sector heading for a downturn
The past 10 years have been very good for investors in commercial property, outperforming UK equities and UK bonds with returns of 85% in the last five years.
Despite these excellent gains, the question remains that with such high returns, can it last? Some commentators believe that the sector is still blessed with low volatility while providing both income and capital growth. Others warn that any period of growth must be balanced with a period of reverting to averages. The best time to invest in commercial property, they say, is after a prolonged period of stagnation and poor returns, ie. not now. The question investors have to ask themselves is, how long is this fruitful period likely to last.
Commercial property is geared so heavily to the health of the nation's economy that it bears looking at in relation to future investments. When times are good companies take on staff, open new premises and rent offices, when they are bad those premises will be empty. Perhaps the writing is already on the wall. The Royal Institution of Chartered Surveyors reported in February of this year that enquiries at the end of 2005 from potential retailers fell at its fastest rate for four years.
Some say that offices will move into those spaces left by retailers wary of the economic climate, while others see it as a reflection of the general poor state of the economy. But what is likely to drive this market in the months ahead? GDP growth is below 2%, there's a stagnant housing market, consumer spending is hardly sizzling, and unemployment is gently rising: none of which indicate that demand for office space is likely to rise. Leaving new space to one side for the moment, London is still suffering with 10% vacancy rates on existing space — even five floors of the wonderful Swiss Re 'Gherkin' building are empty. Add to this the four million square feet of new office capacity due to come on stream in the next three years and the dangers for new commercial investment come into focus.
The final issue that may prevent you from moving into this sector is the low yields on offer. The very low interest rates that made the commercial sector so enticing some years ago are now a distant memory. Rents have not risen in line with the rate hikes, producing just 5-6% return, sometimes lower. Which begs the question, if yields are so low, why not place that money in a savings account and ditch the hassle.
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