Institutions lie in wait with £400m spending money at the ready

Institutional investors are queuing up to spend at least £400 million in the commercial property market after failing to find sufficient stock last year, according to a report from Palmer McCormack estate agents. The institutions' preference for the property market has been prompted by the higher relative returns coupled with income security and stable values.

The agency says some institutional investors have been examining their portfolios with a view to diversifying from older, secondary properties. However, due to the lack of supply and competition from private investors last year, they had, as in 1998, turned to forward-funding developments, mainly in the office and industrial sectors, with pre-funding accounting for about 50 per cent of the total institutional spend. Due to the potential development risks, this market sector is almost entirely institutionally led, according to the agents.

Palmer McCormack says despite the substantial appetite from private investors, property companies and investors, turnover in 1999 was restrained by a shortage of investment opportunities. This resulted in significant investment by private investors in the UK, who have been followed by the institutions.

Again, private investors dominated the source of funds for property investment. Buoyed up by falls in interest rates over the first quarter and the continuing momentum of the economy, their desire for property investments has led to record low yields.

The report says there were alternative investment avenues open to private investors, with a number of institutions offering indirect investment products, permitting investors to put money into property in very small lot sizes.

Palmer McCormack says the office market is again the favoured source for investment funds, primarily because this has been where the greatest supply existed. Vendors were encouraged to take profits on the back of strong prices and a favourable Capital Gains Tax regime. One of the most influential reasons for the performance of the office market was the level of tenant demand in prime areas and the continued reluctance of developers to build speculatively on a significant scale, driving prime rents to £30 per sq ft for the first time, in non-designated areas.

The retail market, like the others, has been hampered by a lack of supply, says the report. Very little has been available in prime city centre areas. Very few have been willing to sell due to a lack of available alternative opportunities. In terms of value, the majority of activity was concentrated in a number of shopping centre deals.

The industrial investment market turned over a modest £87 million, or 13 per cent of total turnover in 1999. Unlike the retail market, the problem has not been the relative lack of supply, but the nature of take up - Historically low interest rates are encouraging industrial occupiers to purchase instead of rent.

The leading economic commentators expect continued strong growth over the next few years. Indeed, the ERSI is forecasting GDP growth of 5 per cent per annum for the period 2000 to 2005. While this is a slowdown relative to the recent past, it is nonetheless very healthy and compares very favourable with, for example, GDP growth forecasts for the UK in the same period of approximately 2.6 per cent per annum.

Palmer McCormack says it is this robust economic growth that will continue to fuel fundamental occupier demand, whether for offices, shops or industrial units.

Continued restraint on the part of both banks and institutions to fund speculative office development, coupled with a construction sector nearing capacity and developer reluctance to commit without pre-lets, will continue to restrict supply. As a result, when combined with strong anticipated office take-up, the agency expects office rents to rise.

Palmer McCormack says property returns look set to remain very attractive, when compared with returns available from equities, gilts or bank deposits.

"Overall, we are forecasting total property returns in the region of 20 per cent for the year 2000."