Industrials are top buy for investors

London and the South East continue to storm ahead as the most favoured areas for investment activity in the UK - especially in the industrial sector, which is still considered the "top buy" for deep-pocketed investors with a keen eye for good returns.

According to the latest Investment Property Forum/Estates Gazette survey of investment intentions, the region remains the top choice of 78 per cent of industrial buyers and 71 per cent of office buyers. Investors, property advisers, fund managers and equity brokers who took part in the survey see industrials as being the best buy, while retail is viewed as the top sell. The report confirmed that all three sectors delivered lower returns compared with three months earlier, reflecting the outward movement in yields in recent months. All yields, for both prime and secondary properties, moved outwards. The most significant movement was in the retail sector, where prime yields have moved out 110 basis points from August. Meanwhile, prime and secondary offices, business parks, industrials and distribution were considered to be underpriced, while prime retail units and shopping centres were overpriced.

Unsurprisingly, the UK's weak retail market has meant that investors are selling out of the retail property sector and dropping their total return forecasts for the whole market. The survey reported that the forecasted total returns of 10.6 per cent for last year went down towards the end of the year, compared with 11.14 per cent in August and 14.4 per cent in March - a fall of nearly 400 basis points as the year progressed.

Rental growth predictions in 2000 continued to be revised downwards, except for offices and business parks. The retail sector was again cited to suffer most, with predictions for shopping centre rental growth falling 90 basis points to 2.3 per cent since August. Another barometer for the state of the UK's investment market is the IPD Monthly Index. The survey shows total returns slowing to an annual growth rate of 10.5 per cent in the year to December 2000 - slightly less than the IPF/Estates Gazette survey figures.

It agreed with other survey findings that most of the deterioration in the property sector's performance over the past few months was due to the weakness of the retail sector. Arezou Said of property consultant Lambert Smith Hampton commented: "The IPD figures show that the gap between the three sectors has widened significantly, with total returns for retail properties (6.4 per cent) in December nearly half of that registered for offices (14.9 per cent) and industrials (14.1 per cent)." Investment demand has continued to focus on growth assets such as industrials and central London offices. This has been reflected in investor activity in recent months as investors have sold out of the retail sector. In contrast, offices and industrial properties have been highly sought after.

Said: "Retail properties are likely to remain the least preferred asset type, with the amount of retail properties coming to the market increasing - which will put further upward pressure on retail yields."

The UK economic outlook for 2001 is relatively good. While the rate of economic growth has slowed slightly during last year, the current growth rate is still strong at above the 2.25 per cent long-term trend. But some predict the slowing economic growth will have the most significant effect on property returns. Leading fund managers expect the slowing market and high stamp duty to take their toll on volume after several record years for investment in the UK.

However, the year has seen a strong start, with a clutch of investment deals worth over £350 million changing hands in London's West End and Midtown markets so far, with the biggest-ever single property transaction in Midtown being completed by a consortium comprising Green Property and an Irish syndicate.

The Irish consortium has bought Goldman Sachs' international headquarters on the former Daily Express site at 120 Fleet Street in EC4, from Japanese trading company Itochu Europe for between £245 million and £250 million. The deal reflects a yield close to 6.2 per cent.

The 440,000 sq ft building is let on a 25-year lease at 79,997 sq ft building on behalf of anonymous clients, from German open-ended fund Internationales Immobilien Institut. Last year, investment activity reached a record high, totalling £26.5 billion by the end of November 2000, but the figures were inflated by an unusually high number of corporate deals, particularly quoted companies being taken private. Standing investment purchases, especially by institutions, have fallen since the first quarter.

The UK's largest fund, Prudential, has warned that transaction levels could decline by around 20 to 25 per cent this year. With transaction costs for buying and selling of 7 to 8 per cent, the opportunity to add value by transacting well will also continue to decline.

The FTSE Real Estate index rose 16 per cent in 2000 while the bursting of the hi-tech bubble saw the All-Share fall 8 per cent. Most analysts are advising clients to remain overweight in property at the beginning of the year, but said they would probably take a neutral or underweight view later on.

The corporate activity, which spurred a lot of the sector's growth in 2000, is expected to slow, but analysts predict some companies will keep a reasonable enough discount to NAV to make buy-outs and privatisations worthwhile.

Although rental growth will be lower in 2001, tight supply in the major markets will prevent a 1990s-style crash. Analysts also predict that the quoted sector will outperform equity markets by default as fund managers become more risk averse and switch to property. As interest rates come down, there will be other areas which provide more attractive returns for investors.

In the residential market, developers are looking to overseas investors for off-plan sales of their residential schemes. Re search carried out by international property consultant Knight Frank has found that 41 per cent of all prime London residential property bought in the second half of 2000 was bought by overseas investors.

This compares to 33 per cent in the first half of 2000 and only 27 per cent for the second half of 1999. US purchases have increased from 10 per cent in the first half of last year to 12 per cent in the second. There was a slight fall in the number of domestic purchases of UK new-build stock last year, partly because of uncertainty in the UK market, and partly because sterling has been weakening against other major currencies, including the US dollar.

Meanwhile, the UK's major regional markets saw a 40 per cent increase in reported office investment (excluding portfolios), equating to £1 billion worth of investment purchases last year. A new survey - UK Regional Offices 2001 - by international real estate adviser DTZ reports that Edinburgh and Manchester proved the most popular cities in the UK, attracting nearly half of all regional investment between them, totalling £490 million.

In the last quarter of 2000, investment purchases for the nine markets - Birmingham, Bristol, Cardiff, Edinburgh, Glasgow, Leeds, Manchester, Newcastle and Nottingham - reached £381 million, almost doubling the previous three months' total of £262 million.

William Jackson, DTZ's national co-ordinator for offices and development said: "Developers and institutions have been slow to respond to the demands of the market. Some have questioned whether demand is sustainable - this survey proves that it is. The outlook for the next 12 months looks good. Developers need to go forward and spec large schemes in these areas."

Most of the regional cities saw healthy rental growth averaging 8 per cent, with Edinburgh's prime rents rising by nearly 25 per cent. Manchester and Glasgow also saw double digit growth. Recent rental growth has been underpinned by the increasing shortages of readily available, new, or refurbished, space and increased levels of take-up.

Overall, then, the property sector in the UK is expected to trade at a premium this year and should outperform other assets. And the stock market is expected to remain volatile, with property offering more stable returns.