UK commercial property review 2022

Property Review 2 2022 1200X673px
For financial professionals only

In the first half of 2022, UK commercial property showed great resilience to the prevailing macro-economic headwinds. The asset class performed strongly, offering positive absolute returns while more traditional asset classes experienced heavy losses. However, as property yields continued to fall (due to positive performance) and interest rates moved strongly in the opposite direction, the second half of the year was much less forgiving. The IA UK Direct property sector fell nearly 12.5% from the beginning of July to the end of December, while the first six months of the year delivered around +5%.

Morningstar Graph

Source: Morningstar Direct, 1st January 2022 to 31st December 2022

So why did Property returns change so dramatically? Property valuations typically act with a lag, owing to the reliance on backward looking transactional data in determining prices. The magnitude of the fall reflected higher borrowing costs going forward combined with an already richly valued property market. October delivered the largest monthly negative fall since capital valuations rolled over.

The impact on open-ended property funds

Given the size and speed of the falls, several property funds have begun assessing valuations more frequently. Previously once a month, independent valuers are now determining prices twice monthly to treat customers fairly. This is helpful to ongoing holders, reducing the risk of investors departing the fund at an unfairly higher price if valuations are not up-to-date and aligned to current market values.

As performance tails off, investors often react by selling down their exposures, and we’ve witnessed the cash held on property funds decreasing. Cash is often held to provide liquidity for open-ended daily dealt funds which own illiquid assets such as property. The cash position’s size can be determined by the property environment and cycle, but generally sits anywhere between 15-25%. At the end of November this figure collectively sat just under 15% for the sector. So it’s likely many property funds will be wanting to sell properties to make sure they have enough cash, meaning a further headwind for prices.

Property market outlook

Now that yields look slightly healthier for UK commercial property, there’s an argument that some of the downside risk has been mitigated or even behind us. However, property prices are typically negatively correlated to interest rates, so next year’s returns will likely be determined by how high interest rates need to go to tame inflation. The length and breadth of a recession is also very important for commercial property pricing, as this will impact the occupational market. If rentals are weak then valuations are likely to weaken further, too.

The differentiated return stream and diversification offered by Commercial property in a multi-asset context is attractive, but the long-term viability of the asset class has been questioned. The liquidity situation is well-documented, and the sector’s outflows have been significant, so these funds may find building scale challenging. Early in 2022 we broadened our alternatives exposure by including other areas such as absolute return and infrastructure, which has proved very useful.

This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity.

Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.

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