Office space performing strongly, driven by service activity in the UK, but returns expected to fall across the board over the next two years
Offices are set to remain the best-performing property sector over the rest of 2007 and into 2008 though total returns will decline across all areas over the next two years.
Andrew Hawkeswood, senior research analyst at Knight Frank, said yields are expected to stabilise, with office total returns likely to reach 13.4% in 2007 and 8.1% in 2008.
"The industrial sector is forecast to achieve total returns of 8.1% in 2007 with rental growth steadily improving, albeit remaining low compared to other sectors," he added.
"A forecast hardening of yields at the start of the year means industrial is the only major property sector where yields are expected to move in during 2007, driven principally by strong demand for multi-let estates. However, returns for the sector are projected to fall to 3.3% in 2008 as the yield shift reverses out and capital growth becomes negative."
Hawkeswood believes the prospects for offices appear positive on the back of strong growth in the service sector during the final quarter of 2006.
"Overall, service activity in the UK continues to be the principal driver of economic growth and further to the latest official statistics, recent surveys suggest the sector should remain buoyant moving forwards," he said.
"The strong performance of the services sector overall has helped the office sector over the past 12 months. Rental growth improved steadily throughout 2006 to stand at 6.2% over the 12 months to December. As speculation grows over how much more yield shift can be achieved, investors are now placing a greater emphasis on rental growth potential, which has helped fuel activity."
Looking to the retail sector, Hawkeswood said figures suggest the latest round of interest rate rises have yet to make an impact on consumer spending levels, with sales volumes rising by 1.4% during the final three months of 2006.
"However, the sales figures for January should provide a more realistic barometer for the market," he added.
"In 2005 a similar situation occurred with increases in sales volumes during November and December followed by a 4.4% fall in January, wiping out the positive effects of the earlier rises. Many commentators are speculating that this may happen again."
Concerns surrounding the consumer are becoming more apparent in the retail property market, Hawkeswood said, with total returns over the 2006 calendar year the lowest of the major property sectors.
"Despite the resurgence of the office sector during the year, retail returns remain strongest over three and five years.
"Returns have been bolstered by the strong performance of the shopping centre and retail warehouse sectors, which produced rental value growth over the year to December of 4.6% and 2.9% respectively," he added.