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Finding Value In UK Real Estate in 2017

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Many Real Estate investors we speak to suggest that we are approaching the peak of the UK Real Estate cycle. History suggests cycles are on average around 8 years in duration and we are well past that now. But quantitative easing and continuing low interest rates mean the original rules are being rewritten. When judged from a historic perspective everything looks expensive and with continuing uncertainty in many areas not least political it would be easy to stay out of the market until the direction of travel becomes clearer. However, we think an opportunity exists in 2017 for selective buyers of assets, and people with experience and skills to navigate the markets.

Let’s start with the fundamentals as this is always the safest way to invest.  Firstly, population growth in the UK is almost certainly set to continue whether we are in the EU or not, with a 3m extra people forecast over the next 25 years just from increased birth rate, and 6m growth due from non-EU migration according to the ONS. At the same time the UK housing stock is consistently growing at about half the required level to meet demand. Secondly, we think that government indebtedness and deficit will continue to dominate economic policy, with interest rates in the UK likely to be lower for a long time to come. Finally, we think a rapid evolution in technology such as Artificial Intelligence, on-line connectivity and robotics will dramatically change the employment market and the consequent utilisation of real estate.  So how do we use these themes to invest wisely?

Firstly, investing supported by underlying demographics will help investors deliver a better return when adjusted for risk. The simple laws of supply and demand means that in overall terms residential prices will continue to rise and even if people cannot afford to buy residential assets, they will need to rent somewhere to live. Combined with the changing landscape of the economy this means redundant commercial properties, often located in well-connected urban areas, will need to be redeveloped into more valuable residential accommodation.

Secondly, the attraction of income that comes from core properties let to high quality tenants will continue for investors. The values paid for ownership of these long term leases will increase given that the average property yield remains about 400 bp over the cost of 10 years UK government bonds. Finally, the technological changes will lead to demand for more flexible (and probably less) offices space and less retail space, but more logistics and mixed use environments. We think that the winners will be entrepreneurial and customer focused landlords who respond proactively to corporate consumers that are increasingly demanding of a high quality service.

With all of the political uncertainty in the UK any investment strategy in 2017 will require flexibility in buying, but we believe that this cannot replace the need for a long term view.

By Alex Price, CEO of Palmer Capital