January 9, 2016
As we head into another year it’s worth pausing and asking ourselves where the UK property market is going, particularly as 2015 saw a much quieter finish than any of the year-ends since the recovery began.
Investment market momentum stalled in Q3 and many of the UK funds closed for new business in October or November. The occupational market may also have slowed, but this is likely to be to a lesser extent and possibly just a seasonal adjustment.
Looking into 2016, our house view is that the year will be dominated by a few key issues. First, we expect to hear more about the slowdown in China, despite official figures suggesting everything is fine. This will affect commodities pricing (the equities market), overseas investment by Middle East and Asian institutions in the UK, and overall global economic growth.
If that wasn’t enough, we also worry that while the European Central Bank stimulus policy has kept everyone smiling, it doesn’t really solve the underlying economic issue of a mismatch within the euro zone members. We think that southern Europeans will continue to worry about employment and growth, and the north Europeans about immigration and defending the euro (from which their exports benefit hugely).
Within the UK, Brexit will grab the headlines, and as with the Scottish referendum, it is likely to be a closer fought battle than the business community assumes. While we suspect we will stay in, an exit could see interest rates (and yields) rising to defend sterling, and the occupational market stall until the political picture becomes clear. Much more important than the political huffing and puffing will be the fact that UK growth continues to be driven by debt-led consumer demand and a rising asset pricing, neither of which are long term solutions.
For the property industry, we expect that further construction price inflation, reducing government capital expenditure and increased building obsolescence will provide challenges to landlords and developers alike. We also worry global investors see UK real estate as relatively expensive, and are increasingly reliant on rental growth to deliver the returns. Finally, we think our corporate customers will increasingly want to occupy sustainable and technologically enabled real estate space fit for the smartphone generation, and will expect a much stronger consumer focus from us, their landlords.
However, before we all run for the hills, there are reasons for optimism. There is a growing urbanised population looking for somewhere to live, set against a limited construction capacity and low availability of suitable land. The government may want more homes built, but policies that boost demand (help to buy) and reduce the desire and ability of the social housing sector to develop (annual rent reductions) are very unlikely to help balance the market. Given this, we think housing will remain structurally undersupplied, rewarding the producers of new residential assets (both for sale and rent) with continued outperformance.
In the commercial property world, the increasing replacement cost for offices and the occupational/legislative requirements for better-quality space will almost certainly continue to underpin office rental growth in most commercial centres. Finally, while interest rates will need to rise at some point, it is likely this will be deferred by quantitative easing, and be slow and gradual, making the yield characteristics of commercial real estate attractive against alternative asset classes.
The areas that we expect to outperform are at either end of the risk spectrum, a type of barbell investment strategy. At one end, we believe longer dated commercial investments to quality tenants will, using sensible leverage, provide an excellent medium-term return to investors. At the opposite end we are focused on grade-A real estate leasing risk across all sectors and new business space or residential development in urban areas (if land can be acquired cheaply enough) to create future core assets. These will be attractive to investors and occupiers alike regardless of the market cycle. Between this, there will be profits to be made from smaller, asset management-intensive, secondary assets, but as most politicians will tell you, the middle ground is a dangerous place.
So, as we enter this new year, let’s first hope the office party photos didn’t make it onto social media, and secondly that our highly traditional industry continues to adapt to the rapidly changing global environment and client needs.
Author: Alex Price, CEO at Palmer Capital