Inflation in the UK has risen to its highest level since March 1992. The Office for National Statistics (ONS) revealed that accelerating food and energy prices impacted by Russia’s invasion of Ukraine could propel inflation even higher. As the UK economy enters a period of stagnant growth, the new data will be uncomfortable reading for the Bank of England, who have set a mandate to keep inflation at 2% over the long-term.
How does this affect commercial property?
Traditionally, both capital values and rental income haven’t kept pace with inflation in the UK.
There have been previous long periods where certain sectors have delivered strong returns above inflation, with extremely attractive risk-adjusted returns. Retail rents kept pace with inflation over the last thirty years prior to 2010 but have slipped away considerably since. It’s now estimated that over half of all retail tenants are paying rent prices way over the rates we see in today’s market.
In contrast, the industrial sector is the only sector to have exceeded inflation over the long term, and there are strong grounds for this to continue, coupled with the fact that almost two-thirds of industrial tenants are currently paying rents below today’s rates. The Office for National Statistics (ONS) discovered that the UK’s transport, logistics and warehousing sector has almost doubled since 2011 with logistics firms having also grown eight times faster than retail overall over that period.
Rents determined by the economic cycle – Cyclical Properties
Properties with tenants whose ability to pay rent is determined by the economic cycle are normally found within sectors identified as offices, retail, and leisure; are called cyclical properties. Non-cyclical properties are classified as properties with tenants whose ability to pay rent is not determined by an economic cycle. These can comprise of government-backed rental payments from healthcare properties, social housing, care homes and any other facilities that are immune to economic cycles.
Commerical property rents
Commercial property rents are generally exceptionally secure, with overall rental levels generally recovering after each recession. Occupiers are, on average, tied into leases and will normally make many other savings in difficult times before vacating their premises and surrendering their lease and will more often than not, cut their dividend before they default on a lease. It’s hard to envisage further yield hardening in prime offices and logistics unless base rates remain markedly higher throughout the mid – 2020s.
The property market in the UK is also upheld by key fundamentals. Compared to pre-2008 the UK market is in considerably better shape than before the global crash. Supply and demand dynamics are well balanced. Supply was constrained and demand has risen across a number of sectors but mainly industrial and logistics which is unlikely to change.
Investors with diversified portfolios should feel confident that they can see out any issues that a rise in inflation may bring. Good market discipline combined with sensible valuations and a balanced supply and demand means that UK real estate is well placed to remain on an upward curve.
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