Take advantage of the commercial property gap

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UK commercial property has bounced back by nearly 20% since its low in June 2009 and could have much further to run.

In particular, there is a growing gap between prime property in central London, where capital values have recovered by 38% since the low spot, according to real estate adviser CB Richard Ellis, and secondary properties in regional towns where prices remain flat on uncertainty about rental levels and tenant demand.

Although current indicators suggest sustained but slow recovery throughout 2011 overall, these substantial variations could become even more marked and present trading opportunities.

Prime retail space is climbing, particularly shopping centres that are a destination in their own right and can demonstrate a proven track record and footfall. In today's marketplace, retail outlets have to perform well to stay.

There are also good opportunities around the fringes of grade A real estate, made up of properties on the fringes of the first tier, such as less glamorous offices in central locations and qood quality offices in slightly smaller cities.

Office space is also recovering, partly due to the dearth of new development. Property firms have reported 30% rental increases in 'trophy' buildings – such as 'The Building' on the corner of Bruton Street and New Bond Street in London's West End – over the past year, and significant tightening up in rent-free periods.

"Occupational demand for commercial property is highly correlated with employment, which remains a worry in places, but not everywhere," says Guy Barnard, fund manager of property equities at Henderson.

"It is a highly differentiated market. London and the South East are doing well, while the regions are more reliant on the prosperity of public sector workers who have taken the brunt of many of the austerity measures."

Quoted property companies are well placed to take advantage of the recovery, as they have spent the last year rebuilding their balance sheets, particularly in the US where REITs (real estate investment trusts) have a significant cost of capital advantage, having repaired their finances early on. US REITs are therefore in a particularly strong position to take advantage of the forced selling opportunities presented by banks and receivers.

REITs have also been boosting their dividends and the consensus estimate is for a dividend growth rate of 10% a year for the next three years, producing a total return of around 14% a year. The latest US GDP figures suggest growth of 3 to 3.5%, another reason to be optimistic about a continuing rebound.

One highly liquid way to play the strengthening property market is to make a spread bet on a REIT. In the US, you can do this on well-regarded shopping mall plays such as CBL (CBL) and Associates and Developers Diversified Realty (DDR).

In the UK, spread bets on British Land (BLND) and Hammerson (HMSO) are popular. "Clients seem happy to run longer-term positions on these," says David Jones, chief market strategist at IG Group. "At the moment, it looks as if there are expectations for further medium-term gains here, now the shares have almost recovered after the Japan-inspired sell-off."

There are also easily tradable exchange traded funds (ETFs), which are more volatile as entities than the underlying property held by their constituents. With good timing they can deliver attractive gains.

To play the rebound in US company balance sheets, for instance, iShares FTSE EPRA/NAREIT US Property is a relatively widely diversified portfolio, compared with the iShares FTSE EPRA/NAREIT UK Property ETF, which is highly concentrated in Land Securities and British Land.

The Asian REITs market expanded by 47% last year with some enormous IPOs, such as Sunway and CapitaMalls Malaysia Trust. ETFs that access this market include iShares FTSE EPRA/NAREIT Developed Asia, and Claymore AlphaShares China Real Estate.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

This article was taken from the May 2011 issue of Money Observer.