Investment Property Databank’s annual performance figures for 2003 are based on the analysis of 10,800 properties, valued at £105bn (E156bn). The IPD Universe currently covers 237 separate UK portfolios – equivalent to three quarters of the direct property assets of institutions and quoted property companies.
Last year saw another solid performance from the commercial property market, as total returns on standing investment properties improved to 10.9%, from 9.7% in 2002. Property’s total return of 10.9% was almost mid-way between equities with returns of 20.9% and gilts with returns of 1.8%.
Property returns largely reflected a further favourable decline in yields in 2003, with fears that a recovery in equities would lead to mass exodus of capital out of the property market proving to be unfounded. While traditional UK institutions were net sellers of property last year, sustained demand from private investors and German open-ended funds pushed the all property equivalent yield down by 40 basis points during 2003, boosting capital values by 5.1%.
This lift meant that capital values continued to rise steadily, even though rental values fell. In fact, rental values slipped by a further -1.6% in 2003, although most of the decline occurred in the first half of the year before the pick-up in economic growth.
The commercial property market in the UK is made up largely of three sectors; at the end of 2003 retails, offices and industrials accounted for around 50%, 35% and 15% of the total IPD Universe respectively. The wide differences in performance across the sectors in 2003 were largely a result of variations in rental value growth.
Retail total returns improved to 15.5% in 2003 from 14.1% in 2002, industrial returns crept up from 10.8% to 11.3%, while office total returns were largely unchanged on the previous year at 3.2%.
Office rental values fell by -10.1% in 2003 contrasting with a rise in retail rental values of 3.7%, maintaining the robust trend of the three preceding years. Meanwhile, industrial rental values were flat. Yield movements broadly reflected the pattern of rental trends. A 38 basis point (bp) cut in the retail equivalent yield in 2003 came amid renewed investor enthusiasm for the high street. Meanwhile office and industrial equivalent yields fell by 29bps.
The one consolation for office investors was that because of the protection afforded cashflows by the upward only lease provision, not all the fall in rental values fed through immediately to office capital values. This cushioning effect, termed the residual by IPD, added around 3% to returns last year – without it office returns would have been zero.
The divergence in retail and office rental values reflects sharply contrasting demand and supply pressures. In the office market, the fundamental problem has been falling employment and a large increase in the supply of second-hand space available for sub-letting. The greater emphasis on cost control means that occupiers appear to be much less willing to retain surplus space, than was the case 10 years ago. However, speculative development was less of a factor than in the early 1990s.
Retailers on the other hand enjoyed strong volume growth last year, thanks to the UK consumer’s seemingly insatiable appetite for debt, although profit margins remained under pressure as a result of competitive pressures. As was the case in 2002, retail warehouses recorded the strongest rental growth last year, as a buoyant housing market fuelled demand for bulky goods and as tight planning controls limited new out-of town development. In the industrial sector, the main drag on rental values was the large amount of second hand space released back to the market as a result of the prolonged recession in manufacturing.
The table shows how the pattern of returns witnessed in 2003 compares with previous selected periods over the last 10 years for the retail and office sectors.

The pattern of returns in 2003 was in line with that of the last three years, with retails clearly out-performing offices. Throughout the last three years, demand for space has been strong in the retail sector, thanks in part to resilient household spending. However, the booming housing market has had a particularly strong impact on out-of-town retail sales, which have driven much of the growth in rental values in the retail sector. Furthermore, as the global economic outlook has weakened investors have seen retails as the “safest port in a storm”, and the consequent flow of money into the sector has bid yields down, boosting capital values by a further 2.4% per year. In the office sector meanwhile, a severe weakening in the outlook for internationally focussed financial and business services has dampened demand for space. Rental values fell on average by -4.7% per year, depressing returns to around 5% per year.
One key pattern to emerge from the variations in property sector returns over the last 10 years in the UK is that while offices tend to do best at the peak of the market cycle, retails tend to fare better during leaner periods and will generally lead upswings. It remains to be seen at which point over the next couple of years investors will begin to make the move away from defensive retail plays and into more cyclical office stocks.

Dominic Smith is a senior researcher at Investment Property Databank (IPD). E-mail: