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Reit generation

The introduction of Reits next year comes as investors seek diversification away from equities and gilts.

The specialist sector remained the most popular net retail sector in October with inflows of £519m, of which £379m was invested in property funds within the sector. These are still positive times for the property market and 2007 is set to be another strong year as investor appeal continues.

We expect the economic backdrop will remain favourable to property. Recent high returns were derived from a belated property repricing for a lower inflation environment and, with economic growth expected to run at or above the current trend over the next few years, there will continue to be positive implications for rental growth.

In recent years, much of the market’s performance has been through yield compression but this will not continue indefinitely. As this weakens, income growth will play an increasingly important role in delivering strong returns.

Even though property yields are at a record low, we anticipate further decline as domestic and overseas investors seek a home for their allocations to the sector.

Investor demand for property assets shows little sign of weakening and tenant demand, particularly in the office sector, is improving. Stock selection and proactive management of portfolios will be crucial in delivering performance. The office sector has been this year’s top performer and we predict Central London offices to again be top of the list, followed by industrial, with retail bringing up the rear after a long run at the top.

Rental growth in Central London is well above trend and rising. The South-east is also set to fare well but later in the cycle and very centre-specific.

Industrials’ steady yearon-year performance has delivered good long-term returns and the prospects continue to look solid. The segmented retail market will offer opportunities, particularly in open A1 retail warehouses and secondary shopping centres where there is opportunity to actively manage and create value.

The outlook continues to be strong but investors will inevitably need to adjust to lower return expectations. Our forecast for 2007 is an 11 per cent total return and an average of 8.9 per cent over the next three years.

This year, strong total returns have been delivered in a period of below-trend rental growth and much of the performance has come from yield compression. We anticipate rental growth to be more accretive to returns.

Any outlook for 2007 cannot fail to mention the introduction of real estate investment trusts. The UK is one of the world’s biggest real estate markets, yet we have not had the regulatory framework to enable investing in an onshore public listed vehicle. Investors and advisers will welcome a vehicle which provides liquidity to an asset class which has historically been considered inflexible.

With a backdrop of continued low interest rates, increased investor allocation to real estate as an established asset class and growing requirements for investors to seek diversification away from equities and gilts, Reits are arriving at a good time.

From experience in the US and Australia, where the Reit market is huge, we believe there will be a spike of initial interest and then a gradual increase in use as more firms convert to Reit status. These trusts, some of which will be segmented by property type, will enable investors to have a much wider choice in their property investment.

Elliot Caldwell is head of retail investor products at ING Real Estate

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