Despite the falls, in the first quarter  of  2013, almost £30bn of regional stock delivered flat or positive capital growth, and delivered a higher income return than the Capital, more than the entire central London market measured by IPD, valued at £23bn. This means that even where underlying properties may be of a lower quality than prime space in London, strong tenants on long-term leases can ensure solid income returns,  a key factor in decision-making for investors keen to shift cash out of low-yielding bonds or gilts, but who also enjoy rising capital values. 

 

During the first quarter of 2013,  all property total returns were 1.1%, up from the 0.8%  delivered

in the last quarter of 2012.  Property equities returned 1.2%, narrowly edging commercial property, while equities had a strong quarter, returning 9.7% (MSCI UK). Bonds returned 1.0% (JP

Morgan UK 7-10 year).

Central London, where returns are driven by strong occupier demand, has still contributed to

most of the UK’s growth, returning 2.3% overall in Q1 2013. West End offices at 2.3%, and retail at 2.9% delivered the highest returns, while City offices delivered 1.7%. Returns for the UK excluding London were 0.7%, mainly due to capital values continuing to decline for the majority of stock. Vitally, this decline took place at a reduced rate,  as regional returns improved during the first quarter of 2013, compared with 0.1% in the last quarter of 2012 .

 

Despite recent high profile regional transactions, regional city returns remain muted at a headline level. Lack of finance, weak regional economies and cautious investment strategies are all reasons for this, but nevertheless, there are pockets of outperformance across all areas of the country. 

 

Manchester, Birmingham  and Edinburgh, three of the largest centres after London, all recorded falling capital values, while Cambridge was the only city that saw headline level capital growth in the first quarter. All commercial property delivered an income return of 1.5%  in  the first quarter, while annual income returns to March were 6.0%. Outside of London, due to discounted prices, income returns were 6.5%  for  the year, but rose to over 7.2%  for office and industrial units.  Many institutions have been pushed out of London, unwilling to be drawn into competition with cash-rich foreign investors with alternative investment strategies, instead seeking regional investment opportunities, which look favourable against London’s initial yields of just 4.2%. For investors concentrating on income, second tier cities have a considerable advantage.

 

Birmingham has an initial yield of 7.1%, and Leeds has 7.0%. Values in  both have been discounted by 42%. The UK’s highest income yield was found in Leicester  at 8.3%. The question is whether these income streams can be maintained. Investors remain rightly cautious, selecting assets with strong underlying tenancies or with considerable potential for  active management.

 

This selective approach amongst investors means there are pockets of outperformance below the headline level. In both Birmingham and Manchester, over 30% of properties were recording positive capital growth, and delivered returns higher than the City office average in London. Many cities simply have too much space, a legacy of the construction boom before the downturn. According to  Lambert Smith Hampton, around 27%  of UK office space is obsolete, while space allocated per person has halved over the last 20 years. In many of the second tier cities, it is the office sector that is dragging down returns. In Manchester,  office values in Q1  2013  fell by 1.7%, in Birmingham, 2.4%, while Glasgow’s fell by 2.4%. Retail assets outside of London  delivered a total return of 0.7%, which disguises an extremely divided market. Some cities saw relatively strong retail performance in the first quarter, notably Guildford, but in many others declines continued unabated. Weak consumer demand and spates of retailer insolvencies has driven up vacancy rates in many portfolios. Local Data Company research from the UK’s top 500 shopping centres revealed around 1,779 closures during 2012. IPD’s own statistics for in town shopping centres, which make up almost a fifth of investable retail stock, continued to suffer from  these retailer instabilities, with values falling by a further 1.0% in Q1, and 5.1% over the year. The strongest retail components regionally are often out of town shopping centres and retail warehouse parks, which delivered 2.0%  and 0.7%  returns respectively in Q1  2013, a considerable improvement on Q4  2012. However, those local centres less dependent on discretionary spend, which often boast solid independent occupiers alongside food retailers, are creating value in secondary markets.

 

Phil Tily, managing director for IPD UK and Ireland, said,  “Flat growth means we are not likely to see investors rushing headlong into regional investment. But with institutions increasingly  being priced  out of London, we are likely to see growing acquisitions of regional  assets that possess strong tenancies, and this will slowly draw in broader interest. “Overall, the sector is showing signs of steady improvement and the growth in income demonstrates why pension funds are increasing their exposure to direct real estate.  As property continues to beat bonds, more cash will flow out of fixed income and we would expect inflation-linked deals to become a bigger fixture within the industry over the next year.”

 

Greg Mansell, head of research at IPD, said,  “In a flat market the  focus for investors is income,
and UK managers have continued to work their assets to deliver strong returns or in some cases, simply stand still, with values falling around them. “In London and elsewhere, there are assets with short leases that are well  priced, but need active management to secure a new tenant. Conversely, there are secondary assets with longer leases that, provided the tenants are secure, can offer immediate returns with less risk and  at a discounted price. 

 

“The decision now for investors is how much risk they are willing to tolerate. We have shown that the pool of regional assets that offer superior income returns to London, but also capital value growth, is larger than that of London itself, which goes to show that regional assets can hold their own when in the right hands.”