By James Thornton, non-executive chairman, at Mayfair Capital
Last year, the property market recovered strongly from the global pandemic and more than made up for its small
negative return in 2020. Boosted by a strong Q4, the MSCI Monthly Index surprised to the upside, recording a 19.9% total return for commercial property.
Over the past 30 years, there have been several occasions when property returns have reached 20%. Each time this has occurred, it has followed an economic downturn driven by macroeconomic, geopolitical, or financial events.
In the early 1990’s, for example, the market recorded three consecutive years of negative returns amid a deep
recession for the UK economy, which was fuelled by high unemployment and an oversupply of property. The catalyst for the sector’s return to positive territory was the UK being forced out of the European exchange rate mechanism, which enabled the UK to reduce interest rates from a peak of 15%. Unsurprisingly, this triggered a strong recovery for property returns.
In each of these periods, the property market recovery that followed was broadly spread across the individual real estate sectors – which generally rose or fell in unison. However, the attribution of returns in 2021 has not followed this historic trend. Rather, the structural economic changes that were emerging prior to the pandemic and impacting property sectors have accentuated a polarisation between real estate segments.
These structural economic shifts have become clear for all to see. Firstly, online retail sales, which stood at 22.1% in March 2020 at the onset of the pandemic, increased to 37.7% in January 2021. This has since subsided to about 28%, but demand from logistics operators for warehouse space remains unabated.
Secondly, enforced working from home during the pandemic has cemented a flexible and hybrid approach to office work, with the relationship between employers and employees seemingly permanently reset. To attract workers back, offices of the future must be experiential and provide a healthy, inspiring working environment.
Finally, there is a continuing switch away from home ownership towards private renting – particularly among 25-40-year-olds. This has resulted in significant investment in institutional scale private residential for rent.
Against this background, of the 19.9% total return delivered in 2021, offices returned just 5.1%, retail 14.6% –
boosted by retail warehousing at 24.9% – and industrial 38.2%. Moreover, only industrials delivered rental growth
above inflation, with 8.9% over the year compared with retail at -3.1%. This is strong evidence of sector polarisation within the UK property market.
As such, portfolio performance in 2021 was entirely determined by portfolio construction and sector allocation. This is clear in the performance of funds, measured by MSCI in its UK All Balanced Funds Property Index with a high industrial and logistics exposure inevitably did best – comfortably in excess of 20% total return – while funds with significant exposure to shopping centres and high street shops continued to struggle, underperforming the average.
Looking ahead, we expect this property sector polarisation to continue, although the differential will likely narrow. Some sectors still have scope for yield compression, and the weight of capital into some markets will drive returns in anticipation of rental growth. London is expected to attract particularly high volumes of international capital over the coming months, and we expect its yield premium over European office markets to narrow.
Logistics will continue to perform well, but the scope for further yield compression will diminish, making rental
growth prospects even more critical. We expect a stronger performance from offices in the year ahead, although the difference between winners and losers in the sector will widen.
Overall, 2022 should be another year when commercial property delivers returns above inflation with a relatively
attractive income yield. Higher interest rates will impact fixed interest returns, while the equity market looks set for further volatility with the ongoing rotation away from growth tech stocks towards value.
A commercial property portfolio aligned to take advantage of such thematic shifts is best placed to deliver an
attractive real return and provide insulation from volatility – in a year when geopolitical and economic risks look set to increase. With their thematically aligned portfolios, Mayfair Capital’s core and core plus funds strongly
outperformed the Balanced Funds Index in 2021, and they look well placed to prosper through 2022 and beyond.