PropertyJul 24 2014

Property ‘the perfect inflation hedge’

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Real estate should continue offering a medium-term inflation hedge in most global markets, with 6-8 per cent annual real returns, according to Standard Life Investments (SLI).

Anne Breen, head of real estate research and strategy at the group, said this depended on several key assumptions, primarily GDP growth remaining at about trend rates through to 2017, and inflation staying within target range.

“Analysis under [our] central scenario of modest inflation for the medium term supports a real-estate portfolio [with a] balance of open-market rent reviews (OMR) and index-linked leases,” she added.

“An approximate allocation of 60 per cent OMR and 40 per cent index-linked would optimise expected returns from the UK market in the next five years, assuming inflation at about the target rate and trend levels of tenant demand in 2014 and 2015.”

According to SLI, under alternative conditions such as high or hyperinflation, a portfolio skewed towards open market rents would be better placed to optimise returns and protect against inflation.

Looking at why real estate can continue to offer hedging as GDP growth improves, Ms Breen said one positive of the debt-fuelled run up to the top of the property market in 2007 was modest levels of construction.

“Available grade-A stock in a recovering tenant market remains in modest supply,” she added.

“This supports expected rental inflation in 2014 and we expect pressure on rents to remain positive, with banks still negatively incentivised to lend.

“Any resurgence of construction activity and confidence has typically followed a sustained period of above-average tenant demand. Our modelling anticipates average demand at best over the next three to five years in most markets.”

Ms Breen’s research has looked at property’s hedging capacity in various scenarios, including high inflation in the UK during the 1970s and Japan’s lost decade of deflation.

Taking the UK first, inflation from the late 1960s until the end of the 1980s averaged 10 per cent a year, but commercial real-estate rents grew 11 per cent and capital values 9 per cent, earning the asset class its hedging reputation.

Ms Breen highlighted several property-friendly developments over this period, including rent review periods narrowing from 15 to five years.

“Essentially, this marked property’s transition from a fixed interest asset to delivering more of an equity-type return, as landlords were better able to lock in any upside in values more frequently,” she said.

“Over these decades, commercial real estate clearly delivered inflation protection, but the drivers of growth were partly large flows into the asset class, pushing down yields. Rents did keep pace with inflation, but it is significant this was supported by regulatory intervention that stifled new supply.”

As for Japan’s deflationary environment for much of the 1990s and 2000, Ms Breen said the country’s real-estate picture is split in two – the 1980s asset bubble fuelled by excessive debt, and the deflation decade from 1999, where values have eroded due to a lack of growth and absence of price stimulus.

“It will be interesting to observe [the impact of] the inflation policies of Abenomics on real estate asset values in the decade ahead,” she added.

Thirst for property shows no signs of abating as fund sales boom

Property fund sales rocketed by almost 300 per cent year-on-year in May, with the asset class the best monthly seller for the first time in almost five years.

According to the latest stats from the fund management trade body the IMA, investors ploughed £491m into property funds over the month, which not only makes them the most popular fund category among retail investors for the first time since December 2009, but also represents a massive 290 per cent rise on the £126m achieved during the same period last year.

The nearest rival, UK Equity Income, was significantly behind with a tally of £270m.

Wealth managers have cited the accelerating UK economy, the booming residential market and poor value in the fixed income space as being chiefly responsible for driving the funds’ appeal.

While the average Global Bond portfolio has risen 1.1 per cent in the past 12 months and the typical UK Gilt vehicle has edged ahead by just 1.6 per cent, property investors are sitting on a gain of 8.2 per cent, according to data from FE Analytics.

Given the more favourable yields on offer, with some funds pushing towards 5 per cent, Gavin Haynes, managing director at Whitechurch Securities has been increasing positions for some time.

“I am not surprised to see that there is an increase in demand for commercial property,” he said. “The asset class is looking attractive on a number of levels. The upturn in UK GDP in the past year is positive for the sector and provides scope for capital appreciation. However, the increased flows could dilute returns if cash weightings increase.”