Institutional investment bulletin

Citation

(1998), "Institutional investment bulletin", Property Management, Vol. 16 No. 2. https://doi.org/10.1108/pm.1998.11316bab.006

Institutional investment bulletin

Institutional investment bulletin

Keywords Investment, Property market

The property investment market has reached levels of activity not seen since the heady days of the late 1980s. Rising rents and growth in occupier demand, combined with the effects of the widening margin between bond yields and average property yields over the last year have made property look particularly appealing as an investment.

Over the last six months retail sales growth is still steaming at 7.5 per cent on an annualised basis, down from its high of 8.6 per cent over the summer. The business and financial sector is showing strong growth of 6 per cent per annum down from its peak of 9 per cent in early summer. Manufacturing which has seen little growth in this cycle has dropped to 1.5 per cent.

Can the market sustain this level of growth or are we about to relive the boom and bust of the last decade?

Institutions made a net investment in property over the third quarter of 1997 of £153 million, well below that invested over the first two quarters of the year. Total net investment by institutions was £14.1 billion in the third quarter of 1997, £5.8 billion lower than the previous quarter. Net investment by pension funds was the highest since the fourth quarter of 1996 with investment in land and property at its highest level since12Q4 1995. Net investment by long-term insurance funds, investment trusts and unit trusts and property unit trusts decreased in comparison to the second quarter of 1997. Pension funds disinvestment in UK equities has now continued for nine consecutive quarters. Pension funds also continued disinvestment in overseas equities (see Figure 5 and Table II).

After six years of economic growth, rental growth has only just edged ahead of inflation. At the same point in the 1980s cycle, it was already running up to 20 per cent per annum. An economic slowdown before rents have moved to unsustainable levels, may allow rental growth to continue a slow steady climb before the market is flooded with speculative schemes.

While we would not consider the market to be booming, the current activity is expected to continue as occupier demand soaks up vacancies and pre-let new development. As gilt yields drop below average property yields history tells us there must be a re-rating of property. We expect further allocation of property for institutions in sectors perceived to expect further strong rental growth.

Since late 1992 the yield gap between equities and property has been running at about 4 per cent. Even taking into consideration the record performance of equities over the preceding three or so years history tells us that the gap must narrow. Continuing volatility and associated risks in global equity markets combined with very positive projections for investors in property logic tells us that a convergence of the respective yields is inevitable.

Of more importance is the reverse yield gap we are now seeing between gilts and property. As property offers potential for growth as well as a running return, historic yields for gilts have sat above those of property. During the dark days of the early 1990s the gap closed as market perceptions on rental growth and thereby capital growth contracted. Only on two occasions in the last 25 years has property had a higher average initial yield than gilts: in 1993 after exiting the ERM which caused a sudden drop in interest rates, and now.

Figure 5 Percentage net institutional investment Q3 1997

As shown above in 1993 the reverse yield gap was closed within a year with average property yields coming into line with historic trends. Many feel the current position indicates a re-pricing of property in the very near future. As with many market commentators we feel property will be the best performing asset class over the medium term as rental levels rise, over-renting subsides and yields fall further.

Over the six months to the end of the third quarter, total returns for retails stood at 16.5 per cent per year compared to 13 per cent for offices and 13.7 per cent for industrial. Although retail rental growth at 5.6 per cent lagged office rental growth at 6.8 per cent, returns for office property suffered due to the level of over-renting. Industrial rental growth remained fixed through the third quarter at just over 3 per cent thereby not gaining any considerable increase in total returns. As prime yields begin to fall we now expect to see some significant movements on secondary property yields especially if they have added value potential and are subject to a filtering down of prime rental growth.

The question remains on what 1998 will hold for property investment. We expect to see continued rental growth, falling yields and total returns pushing 20 per cent. Combined with the global volatility seen in the equity markets and falling gilt returns the re-rating of investment property in the near future is inevitable. Institutional investors will continue to chase limited stock. If as forecast the economy slows into 1999 we will hopefully avoid the boom bust cycle of the last decade and move forward at a sustainable level.