Guy Glover, manager of the F&C UK Property fund, gives his outlook for the sector after a turbulent 2016.
Five years ago, we looked at the prospects for property if the inflation rate moved higher. As it turned out, the period saw an inflation rate averaging a mere 1.4% per annum and the topic fell from favour.
This has changed with the election of Donald Trump, some stabilisation of commodity prices, and the impact of a weaker sterling on UK prices post the Brexit vote.
Inflation forecasts are being revised higher. The consensus is for inflation to move above target next year and Bank of England data shows the top decile estimates for Q4 2017 to Q4 2019 at around 4.5% per annum.
Inflation can be a positive factor for property. This can be seen most clearly for assets where leases are index-linked in some way. The Brexit vote has led to some downgrading in rental growth expectations and so growing the income stream has become more challenging.
The latest Investment Property Forum Consensus Forecasts predict rental growth to be below 2% pa in each of the years to the end of their forecast period in 2020. In this environment, a higher inflation rate could help support property performance for those assets.
Market GDP forecasts indicate continued positive and improving growth rates from 2017. The supply pipeline in most parts of the property market is muted. The momentum behind the inflation forecasts points to further upward revisions.
Should a rise in expected inflation occur within a growth environment, rental advance could conceivably be above present forecasts and this could produce a stronger income stream for property generally.
The annual income return from property already stands at 5.5% and has been attractive relative to bonds, equities and cash. Despite the recent rise in gilt yields, consensus forecasts still favour a prolonged period of low rates (and weak sterling) which could keep property in favour with investors seeking income.
The situation is complex. Lower sterling can benefit exporters, tourism and attract foreign investment, all of which are positive factors for the property industry whether industrial, retail or offices.
However, inflation also creates more uncertainty in already uncertain times. Inflation could depress consumers' disposable income and sterling's depreciation could raise import costs. Finally, higher inflation also affects real capital values.
In the 1970s, inflation rates hit double digits and investment strategies had to be radically adapted. A return to that environment is not envisaged by the market. Higher rates of inflation than have recently been the norm could pose challenges, but within a framework of positive economic advance the potential to enhance income streams could be improved by higher inflation.
Guy Glover is manager of the F&C UK Property fund