Interest in UK property continues strong as 12% three-year average yield is forecast

The UK seems to have shrugged off the concerns that dogged it late last year and is going from strength to strength. One London-based property agency even predicts that yields for property investments are likely to fall to their lowest levels since the early 1970s. Neil Chegwidden, head of research at Cluttons Daniel Smith (CDS), is bullish indeed and forecasts a 12 per cent average total return per annum for all property over the next three years: "With a clearer outlook for sustained economic growth, we believe that annual total returns to property will average close to 12 per cent p.a. over the next three years. Whilst our forecasts for rental growth remain subdued, we continue to believe that there will be a downward shift in property yields."

He says yields are already under pressure because investors have locked into the reality that property offers a strong and relatively high income stream, as well as the capital gain potential resulting from the property-gilt yield gap.

Earlier this year, the Money into Europe report issued by DTZ Debenham Thorpe - which recently formalised its links with Dublin-based DTZ Sherry Fitzgerald - confirmed the rise in investor interest in UK property.

According to DTZ, Irish investors now account for seven per cent of foreign investment and in the first three months of 1999, a record £1.4 billion sterling of property was sold to foreign purchasers.

With this in mind, thanks to falling interest rates, private investors are also in a position to take advantage of a drop in yields. According to Jones Lang LaSalle data, private investors accounted for 35 per cent of purchases in the first quarter of this year. Mr Chegwidden says: "Furthermore, a return to trend levels and above for GDP beyond 1999, will strengthen rental growth potential, giving investors further impetus to push yields lower."

Sanjay Kapila, senior analyst at Knight Frank, is more cautious but has confidence that the market is heading in the right direction. He believes the market is heading for an upturn in the second half of next year. "It has now firmly put last year's worries about the global financial crisis well behind it. In CDS's Quarterly Property Market Update for the first quarter of 1999, the firm reports that such strong returns will be mainly yield-driven with a 0.5 per cent to 0.6 per cent yield adjustment likely. "Property companies are still taking advantage of falling interest rates to raise finance for new acquisitions and developments and the demand from institutions for property is still strong. It is a strong market." There is still a shortage of suitable stock, he warns, which is holding back the regions from making the leap forward that London is doing.

BOB Clarke, Mr Chegwidden's colleague and senior investment manager at CDS, agrees with Mr Kapila. "The first few months of 1999 have witnessed greater consumer and business confidence and have unveiled a strong sentiment towards direct property. Few investors are prepared to sell for fear of being unable to re-invest in property, as supply remains very scarce."

However, Mr Chegwidden is unsure when the yield re-rating will take place. "Exactly when the yield re-rating, and the boost this gives to total returns, materialises is a more difficult call to make. The adjustment could come mainly in 1999, as investor interest is already very strong. There is also a great weight of money waiting to be spent in the sector but without the stock to purchase, yields, based on relatively low volumes, are being forced down."

He also says that the more likely case is that the downward yield shift of around 0.5 per cent is gradual and is underpinned by the returning prospects for rental growth in 2001 and 2002. "Either way," he adds," a yield adjustment forecast is justifiable and likely, leaving the prospects for property over the next three to five years looking very bright."

In its report, Cluttons Daniel Smith expects offices to outperform other sectors over a three-year horizon, led by Central London, while retail is forecast to underperform.

However, despite a range of retailers issuing disappointing figures, recent reports of retail values contrast with this view. According to the Richard Ellis Monthly Index for May, shop capital values have seen their biggest monthly rise since last June keeping the all property total return at 10.4 per cent in the year to May.

The retail rise also took the annualised growth rate over the past three months to 5.6 per cent - up from 2.4 per cent in April. Year on year, shop rentals rose by 5 per cent and total returns improved to 9.3 per cent, from April's figure of 8.7 per cent.

Peter Damesick, head of UK research at Richard Ellis St Quintin, says: "The May monthly index results support the view that the market has passed a turning point in the last few months. The slowdown in rental growth looks to be levelling out and in the High Street at least, a modest pick up in growth was evident in May. Signs of revival in High Street retail were strongest in the bigger centres and contrast sharply with the recent lacklustre performance of retail warehouses - a major turnaround from 12 months ago. Out of town retail has slumped to the bottom of the performance league with only 1.7 per cent rental growth in the past year and annual total returns down to 8.6 per cent, compared to 20.2 per cent in this sector in May 1998."

The Richard Ellis St Quintin report also confirms that the industrial sector has maintained its lead in annual total returns with 11.8 per cent in May. Offices is just behind with 11.4 per cent.