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Is office space this year’s big investment opportunity?

Lucinda Beeman
Written By:
Lucinda Beeman

Why the office space market is set to boom in 2014 and how investors can take advantage.

Across the country, office space is a particularly ripe market at the moment.

While residential property prices have more or less returned to pre-crisis levels, offices are still being sold at prices 30 per cent below their 2007 peak.

Demand for office space is also starting to pick up as companies look to re-locate to bigger and better sites. However, a lack of major construction during the crisis years means available space is limited.

Fund manager Guy Glover, who runs the F&C UK Property fund, says: “This is a beautiful combination of office occupiers looking to expand against a backdrop of low stock levels, which will lead to rental growth.”

According to Jason Hollands, managing director of adviser firm Bestinvest, UK commercial property in general is closely correlated to the health of the domestic economy and has therefore seen a strong recovery since last summer, principally through capital values rising rather than rental growth.

He says: “Within the commercial property market, the environment has been buoyant for office space, particularly in the South East of England and London.”

However, Glover says there are investment opportunities across the country, not just in central London, which is dominated by foreign investors.

This positive outlook appears to be shared by the multi-manager team at Jupiter Asset Management, which has recently made its first investment into a commercial property fund in more than a decade, telling investors they believe the asset class was a “sensible choice for diversification away from equities and bonds for income generation”.

Why to invest in offices

Glover says there a number of reasons to be positive about office space: it has the potential to deliver a competitive return with comparatively low volatility; it can provide a strong and stable income stream through rent; and the prospect of long-term capital growth remains strong as property prices continue to rise.

According to the IPD Annual Property Index for 2013, office space has yielded returns of 9.2 per cent over three years, higher than both equities and bonds.

Rental income returns last year reached 5.3 per cent, compared to 2.4 per cent from residential property.

Looking forward, Hollands believes that 2014 is likely to be another strong year for commercial property as an asset class.

However, in his view it will be a peak year, as rising interest rates will put pressure on refinancing costs starting in 2015, bringing total projected returns down from 12 or 14 per cent to around 7 per cent.

How to get involved

Private investors who want to dip their toes into the office space market can do so directly or through a commercial property fund.

While it is possible to buy office space as an individual investor, barriers to entry can be high.

Fiona Rowley, who manages the M&G Property Portfolio fund, cites the inherent illiquidity of property and large lot sizes as two major barriers to entry.

For this reason, she advocates the fund approach.

While there are few products which invest purely in offices, commercial property funds – which invest in a range of different property types including retail space and warehouses – can provide individual investors with easy access.

Rowley recommends selecting a large fund with a portfolio well-diversified in terms of location and the type of property held.

For a fund with high exposure to the office market in London and the South East, Hollands recommends the Henderson UK Property fund.

How to pick a property

Glover looks for properties with long-term leases, where you can lock in a tenant and the income they provide for an extended period of time.

He also favours properties that are placed “defensively”, meaning new tenants can be found quickly and depended upon to pay rents equal to or higher than their predecessors.

He suggests checking vacancy rates – the lower the better – as empty properties mean lost income.

“It is stock specific – when we choose buildings to buy we’re very focused on how the building is going to perform. You can have two buildings next to each other and they could perform very differently, so there is some skill involved,” he says.

What are the risks?

Like any asset, the capital value of offices can move up and down based on supply and demand. While partly driven by economic conditions, credit conditions also play a role as many property deals use leverage.

Having low quaility tenants can be another a risk.

Hollands explains: “In tougher times, if weaker tenants go bust you could be looking at periods when sites are sitting empty, not generating rent and hurting returns.”

Liquidity is also a concern –  a property fund manager can’t dump an office block the way an equity fund manager can sell off stocks. 

Finally, your fellow investors in a fund could pose a risk.

If investors in a property fund sell in large numbers the fund could be forced to put a freeze on redemptions. Following issues in the past, many open-ended funds now hold large positions in cash or liquid investments, which in turn dilutes exposure to physical properties. 

Top 10 Performing UK Property Funds Over Five Years

Fund Name  Return over five years 
CF Canlife UK Property Jersey Acc 93.051
Scottish Widows HIFML UK Property 1  58.771
L&G UK Property L 47.968
Ignis UK Property A Acc 44.176
Henderson UK Property A Acc  44.114 
St James’s Place Property Acc  36.960 
Aviva Investors Property Trust 1 Inc  35.444 
SWIP Property Trust A Acc  32.811 
Old Mutual Property A GBP Acc 30.787
Threadneedle UK Property Trust Acc  13.347

Source: Morningstar, Inc (as at 23/04/14)

IPD UK Annual Property Index for 2013

  Total Return (1 year) Income Return (1 year)   Capital Growth (1 year) 
All Property  10.7 per cent 5.7 per cent  4.8 per cent 
Office  14 per cent 5.3 per cent  8.3 per cent 
Residential 13.3 per cent 2.4 per cent  10.7 per cent

Source: IPD UK Annual Property Index 2013

Comparative Data: Annualised Total Returns

  3 Years  5 Years  10 Years 
Office 9.2 per cent  8.7 per cent  7.2 per cent 
Residential 11.1 per cent 11.1 per cent  9.7 per cent 
Equities 8.6 per cent 12.9 per cent  8.0 per cent 
Bonds 4.8 per cent 4.5 per cent  5.8 per cent

Source: IPD UK Annual Property Index 2013