Offices are set to become the best performing commercial property investment in 2007, according to the latest research from commercial property consultancy Lambert Smith Hampton (LSH).
Based on an upturn in occupier demand in most office markets across the UK, LSH is predicting that the office sector will see total annual returns of 14.3 per cent in 2007 - ahead of industrial at 8.8 per cent and retail at 6.4 per cent.
Ed Jones, director and head of investment agency in LSH's Birmingham office, said: "With yields expected to move out slightly on secondary assets over the coming months, we expect total returns in commercial property to be lower than in the past two to three years.
"However, rental growth is likely to offset this, particularly in the office sector."
John Dillon, associate director and head of office agency in Birmingham, believes stronger take-up has led to Grade A office stock now being in short supply in many locations.
He says that developers are addressing this shortage, though there is an inevitable 'lag-time' before new developments come on stream.
"The outlook for the office market remains positive as demand for new and high-quality space remains high and pre-letting activity helps to keep availability rates down," he added.
"Given improving market conditions, we have upgraded our forecasts of rental growth for the office sector as a whole and now expect rents to rise by 8.2 per cent in 2007 before growth falls back to around seven per cent in 2008.
"This growth is especially evident in Birmingham, where pre-lets for buildings which will be completed in 2008-09 are already rumoured to be achieving rental levels of £32 to £33psf, well ahead of the current record of £30psf for existing stock in the city centre."
While the office sector is likely to perform well, conditions are more difficult for the retail market. LSH expects rental growth in this sector to slow down to around two per cent this year.
Dominic Brown, associate director in the retail agency department, said: "The sector has performed better than anticipated and there have been some selective areas of rental growth. However, given weaker consumer spending, there are concerns about the structural changes that are affecting the high street.
"These include additional offerings by supermarkets, more business being taken by the internet - which has been particularly difficult for book, music and travel stores - and competition from out-of-town shopping centres.
"Another sub-sector which is likely to be affected is bulky goods retail warehousing, DIY, furniture and electricals. Saturation of DIY and furniture stores combined with the slowdown in housing, as a result of recent increases in interest rates, may decide the fate of this sector in the coming months.
"Overall, increased competitive pressures are likely to squeeze the middle market further and create polarisation between value and aspirational retailing. To compete successfully, shopping places will need to meet three main challenges: convenience, differentiation and social responsibility."
In the industrial market, demand continues to be driven by distribution.
Nick Ford, director and head of industrial agency, said: "While the rise of internet shopping, improving trade and diversification of supermarkets into the white goods market will provide opportunity for further growth in the distribution market, rising interest rates and a strong pound are likely to hit the manufacturing sector.
"On the whole we expect industrial rental growth of 1.4 per cent in 2007, while distribution is expected to outperform with 2.4 per cent growth."