According to the IPD Global Intel dataset, London continued to lead the UK’s charge towards higher returns. Figure 1 demonstrates the gap between London and its domestic peers, as at Q3 2013. However, the original driver of London’s outperformance – the Central London office markets – has since yielded to the peripheral sub-markets.
The inner and outer London 8.8 sub-markets surround the City, Mid Town, and West End, and the release of the fourth-quarter results of the IPD UK Quarterly Property index revealed that inner London returned 11.5% for the second half of 2013 and outer London improved to 11.9% over the same period. The West End was the closest rival with 10.5%.
London’s good form has maintained momentum, while the resulting capital growth has left income returns relatively low. An income return of 4.4% year-on-year is 160bps above the return from a 10-year government bond. This spread is in line with the long-term aver- age, but it is also low in absolute terms and sensitive to future rate rises.
In an investment environment where investors are struggling to find high income returns in any asset class, higher yielding real estate markets are starting to look attractive, despite occupier risks. Above all, investors’ attitude towards occupier risk in the peripheral London sub-markets has softened now that rental growth has established itself.
Figure 2 highlights the income premium outer London enjoys relative to the West End to compensate for such risks.
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