Legal & General Property advocates a focus on high quality assets given weak economic recovery

At today’s Fundamentals briefing, Robin Martin, Head of Research at Legal & General Property (“LGP”), set out LGP’s view on commercial real estate returns in 2010. “Commercial real estate could produce excellent returns this year. However, in light of fragile economic growth figures released during the first quarter, the best returns will rely on good stockpicking of assets and a selective approach to taking on greater investment risk”. Robin Martin said.

Commercial property values endured one of the sharpest and deepest declines in modern history up to mid-2009. At the same time, there was a broadening in the range of returns achieved by individual portfolios. The gap between the best and worst performing funds culminated in a 24% spread between the fifth and 95^th percentiles in 2009.

As LGP highlighted in a Fundamentals presentation in April 2009, adopting a beneficial ‘risk exposure’ has proven to be a key driver of portfolio performance in the recent downturn, with funds driven by exposure to risk (captured through characteristics such as lease lengths, covenant strength and asset size etc) rather than the conventional sector or regional allocations. Most recently, the strong performance of low risk assets against higher risk comparators has had a significant impact on relative performance between different investments.

While investor confidence has returned to the commercial property market, Legal & General Investment Management (LGIM) believes the UK recovery in 2010 will be relatively weak compared to previous recessions. This is likely to restrain commercial real estate rents.

“A move up the risk curve must be executed with a careful eye on the fundamentals of each asset,” Robin Martin said. “Put another way, whilst high risk premia offer unusually attractive potential for generating outperformance, it is the underlying quality of those assets that can turn that potential into reality. Stock picking, then, has become more critical than ever.”

Given lower levels of liquidity than other asset classes, commercial property managers must use a number of strategies to avoid paying inflated prices. These include sourcing off-market stock opportunities, competing with other purchasers on more than just price and identifying areas of the market where there is less competition. “In essence,” Robin said, “with a significant amount of equity targeted at commercial real estate, strong transactional capabilities and a countercyclical approach to purchasing are two key components that will drive outperformance.”

ENDS.