Retail schemes continue to give the best returns on commercial property investment - and, in the offices sector, the West Midlands is still bucking the national trend with rising rentals and strong occupier demand.
These are the key findings in the latest Lambert Smith Hampton Economic and Property Market Bulletin, which confirms that commercial property is still the best performing asset, although equities are catching up in a new surge of investor confidence.
At the same time, the industrial sector is becoming increasingly dependent on the consumer market, as distribution takes on a more important role. "A pick-up in activity in the service sector is therefore good news," says LSH regional chief executive Craig Bales.
"The retail market is likely to see a slowdown this year, but to remain competitively strong. Consumer spending and the housing market are both forecast to see slower growth this year. With interest rates and unemployment levels likely to remain low and economic recovery gathering pace, the sector as a whole should benefit from higher tenant demand in the medium term.
"The end of the war with Iraq appears to have restored business confidence and removed some of the uncertainty in the stock market, as demonstrated by the recent bounce-back in shares.
"The result was a recovery in equity total returns, but looking at the calendar year, however, property still continues to be the best performer over equities and gilts."
And yet a survey by DTZ Research reveals that property fund managers expect equities to outperform other asset classes in 2003. Net capital flows into UK commercial property are expected to total around #14 billion in 2003, according to Justin Parker, head of national investment agency at DTZ, which has just published its 28th annual Money into Property report.
This figure would represent a fall of #3 billion on last year's figure of #17 billion as lenders continue to become more cautious.
Mr Parker says: "In a nutshell, 2003 can be defined as the year of income as investors look for properties with secure income streams. Given the prospects for capital growth this year, commercial property is likely to remain attractive as investors seek to take advantage of one of the key characteristics of this asset class, namely its high-income return relative to other asset classes.
"The potential for an equity market recovery in 2003 will impact on property weightings. Although, in the short term, there may be a tactical move to take advantage of the upturn in equities, it seems likely that, over the longer term, real estate will account for an increased proportion of investor portfolios."
Drawing on the statistics contained in the new LSH bulletin, which provides a quarterly overview of the commercial property market, Mr Bales reports that the retail sector has continued to strengthen and is now showing an annual total (capital and rental growth) return of 16 per cent.
Industrial property lags behind at 10.8 per cent with offices trailing at a 4.1 per cent total return.
"However, the national office market continues to be dominated by weak occupier demand and over-supply in London and the South-east, where rentals have fallen over the quarter by 7.1 per cent," says Birmingham-based Mr Bales.
"In the West Midlands, the exact opposite is true, with high demand and a shortage of grade A office space increasing rents and total returns, especially in the centre of Birmingham."
According to Mr Bales, Birmingham's record rent of #27.50 per sq ft has been confirmed by the recent letting of 5 St Philip's Place to the Office of the Deputy Prime Minister. "Rents are rising, while investors are prepared to accept lower investment yields on landmark buildings with strong covenants, as they are confident of capital values continuing to rise," he explains.
LSH recently advised travel giant TUI Northern Europe on the sale and leaseback of more than 100,000 sq ft of grade A office space in Coventry to a privately-owned Manchester property company at a yield of 6.5 per cent, while Direct Line House on Livery Street, Birmingham, was sold at a yield of 5.7 per cent to an Irish consortium.
The yield on the latter deal reportedly fell under six per cent as the building is in a stamp duty-exempt zone. The change in stamp duty made a strong contribution to capital growth in April, according to the bulletin.
"Nationally, the office market is not likely to see a recovery before the end of this year, but the situation in Birmingham will remain until the end of 2005, as long as the shortage of grade A space continues," says Mr Bales.
"Over the next 12 months, we can expect higher economic growth to provide better incentive for companies to finance higher investment. Provided the service sector revival reported in recent weeks continues, there should also be a recovery in occupier demand.
"This is likely to impact not only on the national office market but also on the two other sectors, both of which are reliant on consumer and service sector demand."
DTZ Research also talks about total returns of around six per cent on commercial property this year. This is the lowest return since 1995, whereas equities and gilts are expected to deliver returns of 11 per cent and four per cent respectively. Returns are expected to improve moderately to seven per cent in 2004.
According to DTZ, non-bank financial institutions increased their exposure to direct UK commercial property by #1 billion during 2002 - the lowest level of commitment since 1996. The lower level of investment is not regarded as a sign of reduced appetite for commercial property - but reflects the fact that competition for stock is strong after three years of poor performance of this asset class.
According to the DTZ survey, while commercial property investment is expected to remain positive, net capital flows by institutions are expected to fall to #700 million during 2003, compared with #1 billion last year.
Investor appetite from the pension funds and insurers for retail parks and retail warehouse units remains strong, according to DTZ, and despite continued tough conditions in the manufacturing sector, standard industrial units and warehouses continue to feature high on their list of priorities.
The office sector continued to be the least favoured commercial sector, particularly M25 towns and Central London offices.
Cross-border acquisitions of UK commercial property remained strong throughout 2002, with purchases totalling #6.6 billion. That said, net investment by cross-border investors was negative for the first time since DTZ Research began monitoring activity, due largely to a small number of large portfolio sales.
Purchases by German investors are said to have increased substantially since 2000 when it accounted for just over three per cent of total cross-border investment. This year is likely to see an unprecedented level of investment by this investor group, according to DTZ, with first-quarter purchases accounting for almost 44 per cent of cross-border investment.
Offices continue to attract the lion's share of investment, accounting for 60 per cent of the total investment recorded for the first quarter - ten points higher than the level recorded in 2002.
This volume can be attributed in part to the strength of German open-ended funds' activity, which is typically targeted at prime office property investments.
Negative net investment is expected to be a transitory feature of the market and positive net investment by non-domestic investors of around #2 billion is expected this year, with acquisitions totalling around #5 billion.
US and German money flows are expected to continue to dominate inward investment.