Property to return 7% in 2011, as equity correlation continues to decline, says Ignis Real Estate

• Commercial property returns during the year to be driven largely by income
• Sector again offering diversification and protection benefits over equities and gilts
• Correlation with equities continuing to fall away

Commercial property will deliver an income-driven total return of around 7% in 2011, offering investors a measure of protection amid current volatility as the asset class continues to decouple from equities, according to Ignis Real Estate.

Alan Gardner, head of property research at Ignis, believes property will deliver a total headline return of around 7% over the year - comprised largely of income return, with capital growth likely to remain muted – while equities will deliver only ‘flattish’ returns with higher volatility. Indeed, Gardner points out that the correlation between equities and property has fallen away from its peak during the last cycle, which should provide greater diversification and protection benefits for investors, particularly with spreads between property yields and equities / gilts remaining wide.

“Average property yields still compare favourably to other asset classes when considering the higher levels of inflation the UK is experiencing at the present time,” he says. “Equities are not cheap – pricing is a bit below pre-credit crunch levels – and gilt yields are at a point where gilt prices will only rise if the UK economy struggles to the extent where the stimulus provided by record low interest rates is still needed. This supports the view that property at the present time is fully, but fairly valued, and that any further write-down in values is yet to be fully justified by falling rental income.”         

Gardner says Ignis’ latest forecasts suggest that average rental value growth will remain relatively weak over 2011 and 2012, expanding by 1.6% and 2.4% respectively. Retail rental values will be, in his view, flat in 2011, dragged down by weak consumer spending, although the outlook is much brighter in the capital. “The real rental story is in London offices and retail, which are expected to deliver further rental growth over 2011 and 2012,” he says. “Offices, boosted by the strong London weighting, will be the top performing sector in 2011 and 2012, although the industrial sector will come close in 2012, benefitting from economic recovery plus starting from a higher yield.”

Aside from central London office and retail assets, Gardner believes there will be ‘limited’ variation in headline total returns. “‘Rest of UK’ offices and ‘Rest of UK’ shops will in our view struggle,” he says. “A substantial gap has now opened up in pricing between London and other UK markets. This is a feature of the market across property types where a synchronised downturn has been replaced by a strong recovery in London and rebound in other markets, which has now run out of steam. Most sectors look set to deliver performance driven by income return with limited capital growth.”