2017 real estate market outlook - m&g investments · 2018-01-03 · 4 occupier demand remains...
TRANSCRIPT
Part of the M&G Group
Real Estate Market Outlook UK
Janu
ary
2017
For investment professionals only
Front cover photo: Hardman Square, Manchester.
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Executive summary• Economy shrugs off initial Brexit-related hit to confidence, sentiment rebounds
• Demand/supply imbalance to support a healthy industrial occupier market
• Investor concerns abating after turbulent summer
• Moderate outlook for performance although downside risks remain
• Defensive investments likely to hold investors in good stead over the short term
Although economic conditions remain healthy for the
time being, the consensus view continues to be that we
shall see a slowdown in 2017’s activity. However, the
expected slowdown is relatively modest, with economic
activity seen to be easing to levels more akin to the UK’s
larger European neighbours.
There remains little conviction around what sort of
relationship the UK will eventually have with the EU,
although with the government seemingly taking a
hard line against the free movement of EU citizens
to the UK the probability of a “soft Brexit” may be
more limited than previously anticipated. That said,
negotiations are yet to begin and speculation is
constantly evolving. So with the only certainty in this
process being uncertainty there is still significant hope
that a mutually beneficial agreement will be reached.
Whatever does happen, both the UK government
and the Bank of England have made it clear that
their primary focus throughout will be to maintain
the stability of the British economy, whether through
accommodative monetary or fiscal policy. The Bank’s
policy interest rate, for example, has already been cut
to a new historic low of 0.25% and is likely to remain
at that level for the foreseeable future, something that
will be supportive of the country’s underlying economy
and real estate markets.
Economy proves resilient in face of Brexit uncertainty
Initial fears of a sharp uncertainty-driven slowdown
in the economy have, as yet, proved unfounded, with
GDP continuing to grow at a healthy 0.5% pace in the
third quarter of 2016. This healthier-than-expected
picture of growth has echoed across various economic
indicators. Sentiment in particular has bounced back
after slumping initially in July 2016, following the June
vote to leave the European Union, so it would seem that
British consumers and businesses are looking to carry
on pretty much as usual despite the Brexit vote. At the
same time unemployment has continued to fall and in
October 2016 retail sales grew at their fastest annual
rate for 14 years.
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USA Canada Germany UK France Japan Italy
Fig. 2: UK expected to see similar growth to many other G7 countries
Source: Consensus Economics, December 2016.
Fig. 1: Sentiment rebounds from Brexit falls
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Service sector Manufacturing sector
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Source: Bloomberg, December 2016.
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Occupier demand remains resilient…Fundamentally, nothing has really changed in the
property occupier market since the EU referendum vote.
IPD All Property rental growth has shown some signs
of moderating, from 3.3% p.a. to 2.6% p.a. in 2016, but
remains healthy. There is also significant divergence
across different parts of the property market: much of
the slowdown to date, for example, reflects the weaker
Central London office market, something that was
anticipated well ahead of the referendum due to more
market-specific factors.
… although some caution evident in the Central London office marketCentral London offices, and the City in particular, are
likely to be at the epicentre of any more significant
weakness in the overall occupier market. With the
City likely to suffer the most from the impact of
Brexit on EU-related trade in the financial and business
sectors (particularly if passporting rights are lost), we
expect occupiers to hold off from taking space in the
short term. Indeed, post-referendum take-up is already
relatively subdued, with Brexit, affordability concerns,
and rising supply all placing pressure on the occupier
market. We think this may lead to falls in rents, or at
least rising incentives, but we expect these falls to be
relatively limited (in the region of only c. 5-6%) thanks
to the wider economy’s continued growth, which should
underpin general demand for space, and a scaling back
of the development pipeline.
The regional UK office market appears more resilient
given grade-A availability is very low and there is limited
new supply coming on line in the short-term. Take-up here
is driven more by domestic demand (which has proven
surprisingly buoyant) than by international financial
services. That said, the market is becoming increasingly
bifurcated with the likes of Manchester, Birmingham,
Edinburgh and some South East towns such as Reading
and Maidenhead moving ahead of the rest, helped by
strong and improving transport infrastructure, young
educated workforces, and government support.
Continued support for industrial rentsDespite the recent political uncertainty, occupier
sentiment for the industrial sector has remained
upbeat. This reflects, at least in part, the fact that
a large share of current and expected demand is
from companies such as e-tailing giant Amazon,
which are looking to take advantage of the ongoing
structural change in the sector. This race for space
shows no sign of slowing as yet, so demand continues
to exceed supply even though it has encouraged some
speculative development as investors and developers
try to meet the need for new space.
Recent events have led to a slowdown in new starts,
particularly in the case of distribution warehouse
developments. Those that are in the pipeline remain
firmly focused on core hub locations, where the supply of
existing quality stock is particularly acute and demand
for space remains strong, such as London and the South
East. Meanwhile, availability for multi-let units is at
record lows, adding to the pressures in the sector. As a
result, we expect rental growth to remain strong in the
short term.
Mixed outlook for retailThe recent recovery in the retail property sector and
strong retail sales are likely to be curtailed by a number of
headwinds that are expected to impact the sector over
the next couple of years. These include higher inflation,
the introduction of the national living wage, business
rate revaluations, and an increasingly competitive retail
environment. These headwinds are set to occur during
a period in which retailers have continued investing in
supply chain and omni-channel capabilities. However,
different retail types and geographies are expected to
be impacted by these headwinds to differing degrees.
We expect the polarisation between prime and
secondary schemes and locations, which is already
evident within the retail sector, to become more
palpable in the near term. Occupier demand is likely
to remain focussed on the best retail pitches, while
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Central London Take-up 10-year average
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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
(Jan-Nov)
Fig. 3: Central London office take-up slows
Source: CBRE (December 2016).
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PAS Industrial – South East PAS Industrial – Rest of UK
Fig. 4: Strong demand and limited supply continue to boost industrial rents
Source: IPD (November 2016).
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increased retailer consolidation and a withdrawal from
weaker towns looks likely to lead to more secondary
space coming back onto the market.
That said, the return of a more cautious approach to
development, given the uncertain political and economic
backdrop, is likely to apply to the food store and retail
warehouse sectors – which should lend support to rents.
Indeed, we expect supermarkets to hold up better, given
the defensive nature of their occupier base and the
prevalence of long inflation-linked leases.
Higher house prices underpin demand for private rentingIn contrast, rental growth in the private rented sector
(PRS) has been strengthening in recent months, albeit
gradually. Tenant demand has continued to improve
across much of the country as the Brexit uncertainty
reduces people’s willingness to buy and high house
prices affect their ability to do so. In addition, the supply
of rented property has actually weakened, adding to
pressure on rents.
The picture in London is more mixed. Activity in Outer
London and the main commuter areas, driven by young
professionals and families, remains healthy, underpinned
again by a lack of affordability for would-be first-time
buyers and the Brexit uncertainty. In contrast, the more
prime, inner areas of the city are seeing increased
supply coming onto the market at a time when demand
is being tempered, leading to falls in rents.
On balance though, away from Central London, the
PRS remains, and should continue to remain, relatively
resilient in the face of economic headwinds.
Initial investor Brexit concerns abatingUnsurprisingly, the EU Referendum result led to some
unease amongst investors: retail investor funds saw net
outflows of c.£2.3 billion in 2016, triggering property
sales as those funds looked to meet these redemptions.
This selling pressure and the uncertainty generally led
to capital values slipping over the summer months.
Nevertheless, the declines were seemingly over before
they began, with values falling by a limited 2.4% at the
All-Property level (IPD) in 2016. Indeed, capital values
have already started to rise again, albeit tentatively, as
renewed confidence and the desire to keep calm and
carry on has allowed stability to return to the market.
UK property yields have risen by about 25 basis points in
2016, leaving the spread above 10-year UK government
bond yields at around 500 basis points, above where it
started 2015 and well above its historic average. That
will continue to provide a healthy cushion for pricing in
the short- to medium-term.
There are other reasons to be relatively positive about
the UK property market. Capital values are, on average,
almost 25% below where they were at their 2007
peak, before the global financial crisis. Debt is also at
considerably lower levels whilst the number of forced
sellers in the market is still relatively low.
One additional and important factor is that overseas
investors do not seem to have been deterred by the
idea of Brexit and its potential implications for the
UK. If anything, the post-referendum depreciation of
sterling has made UK property look more attractive
from an international perspective. Property in London,
in particular, now looks more attractive on a relative
basis, given that prime London yields have risen by
c.25bps, while yields elsewhere in the world have stayed
the same or even compressed over the same period.
the post-referendum depreciation of sterling has made UK property
look more attractive from an international perspective.
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Property yield minus bond yield
Fig. 5: Property retains a healthy risk premium above bonds
Source: IPD, Bloomberg (November 2016).
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Fig. 6: Prime London yields more attractive on a relative basis than previously
Source: CBRE (December 2016).
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lead to a deceleration in the housing (sales) market,
the PRS is likely to benefit as would-be buyers instead
choose, or are forced, to remain in an already supply-
constrained rental market. This should maintain, or
even strengthen, rental growth, helping to offset any
weakness in the owner-occupier market.
• Quality over quantity In times of unease, well-located property with secure
income streams tend to prove most attractive to
investors looking to minimise risk. As such, focusing
on prime and good secondary property should
provide the potential to outperform in the short
term.
• Central London at greater risk Overall, we believe that central London offices will
be affected to a greater degree, as this is where the
change in our relationship with the EU will be most
visible, as well as being the area where pricing looks
most expensive relative to fair value. This is also
the part of the market where we see the greatest
probability of falls in rental values. Similarly, we
expect Central London residential to underperform,
reflecting the fact that, alongside the potential
impacts from Brexit, the sector is also seeing high
levels of supply and weak investor demand in the
face of significant stamp duty changes introduced
in early-2016.
• Maintain a balanced, diversified portfolio With uncertainty likely to be the watchword of
2017, if not for the next few years as Brexit unfolds,
investors should look to limit risk by maintaining
a portfolio that is balanced and well-diversified in
terms of both geography and market segment.
Conclusion
On balance, the UK property market appears to be in
a much better position than we were expecting in the
summer, shortly after the EU referendum. We now look
to be entering 2017 from a position of relative strength
and with a modicum of optimism. However, it is clear
that there are definite and significant headwinds in
place that may affect the market over the next two
years. As such, taking a defensive stance in terms of
portfolio strategy should prove beneficial.
All of that means that the UK property market as it
enters 2017 looks set to face the challenges of Brexit
from a position of relative strength. Certainly, conditions
are much stronger than the industry was previously
anticipating. As a result, while we may see further falls
in capital values due to of the Brexit uncertainty, these
are likely to remain relatively modest and more focussed
at the secondary end of the market.
There are, however, significant differences. Offices and
residential in Central London are likely to feel the
greatest impact from Brexit, while the more defensive
industrial and private rented sectors are likely to be
affected to a lesser degree. Meanwhile, the impact on
the retail sector may be more mixed as uncertainty
leads to slower consumption growth but with prime
schemes with destination appeal likely to be bolstered
by international tourism.
Caution remains an important themeAlthough our base-case scenario suggests that the
market will remain relatively resilient in the short term
there are significant downside risks on the horizon, not
just associated with Brexit but also reflecting other
geopolitical and economic events. Therefore, we believe
that it is important to remain cautious and thus for
investors to position their portfolios to weather any
potential storms that may arise.
• Uncertainty to continue drive towards defensive sectors
The industrial sector, already seen as a defensive
investment from a cyclical perspective but also from
a structural perspective since it is benefiting from
e-commerce-driven change, should hold up well.
Industrial property should continue to see positive
rental growth and only limited upward pressure on
yields.
We anticipate that long lease and inflation-linked property such as supermarkets will also prove
resilient, with its low-risk, bond-like characteristics
always demonstrating significant appeal during
periods of uncertainty.
Away from the property mainstream, the residential sector is likely to be impacted the least by any
ongoing uncertainty: while a weaker economy may
“ “... the UK property market as it enters 2017 looks set to face the challenges of Brexit from a
position of relative strength.
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Emma Grew Research Manager
+44 (0)20 7548 6676
Richard Gwilliam Head of Property Research
+44 (0)20 7548 6863
Christopher Andrews, CFA Head of Client Relationships and Marketing, Real Estate
+(65) 6436 5331
For more informationLucy Williams Director, Institutional Business UK and Europe, Real Estate
+44 (0)20 7548 6585
Stefan Cornelissen Director of Institutional Business Benelux, Nordics and Switzerland
+31 (0)20 799 7680
www.mandg.com/realestate
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