UK – Secondary real estate in the UK could see a recovery next year – and investors should be prepared for it, according to Aviva Investors' global research manager Chris Urwin.

An unusually wide gap between prime and secondary office and retail yields will undergo a significant compression in the second half of next year as the economy improves, he suggested in a research note.

In the meantime, prices for secondary property – defined by Aviva Investors as assets exposed to income risk with a consequent higher yield – could fall even further.

“Today, UK secondary assets look extremely cheap relative to prime assets. Prices may not be at the bottom yet, and they are likely to get cheaper still over the next six months,” Urwin said.

Despite tenuous income security, secondary assets over the long term have outperformed prime, with comparable volatility, according to Urwin.

Moreover, prime pricing would be vulnerable to an increase in government bond yields as a result of economic recovery or a retreat from investor risk-aversion.

However, he was less bullish about the industrial sector, which he believes will continue to underperform. He also warned of broader risks associated with macro-correlated assets were the UK to enter a longer-than-anticipated period of slow growth with weaker-than-expected income growth.

Another potential risk would come from constrained yield compression – characterised by better assessment of income risks and rental growth prospects for secondary assets – created by banks releasing assets onto a recovering market.
Although the end of market deterioration could create opportunities for secondary assets to outperform in a recovery, Urwin said timing would be critical – and difficult to predict.

“The current level of uncertainty makes it difficult to have firm views on the timing of UK secondary assets strategy, but there is a cyclical opportunity for investors to generate outperformance over the coming years,” he said.

David Skinner, chief investment officer for global real estate at Aviva Investors, told IP Real Estate that he expected to see "some normalisation" in investor risk appetite in 2013.

Skinner said this trend was already apparent in wider financial markets but had yet to manifest itself in real estate markets. Once it did, he added, secondary assets would be on the agenda for investors.