Enduring? Dominant? The UK will be punching above its weight for some time to come, as Shayla Walmsley reports
As the topic of a sometimes playful debate at the IPD/IPF conference in November, the UK came out pretty badly. Would it still be a globally dominant market in 10 years time? Apparently not, judging by 69% of a straw poll taken at the time.
Neither of the speakers against the motion - Peter Hobbs, head of business development at IPD, and Matt Richardson, director of European research at Fidelity - is particularly pessimistic about the UK market. Richardson, for example, said the UK will still be punching above its weight in a decade.
In any case, it was doing pretty well for a while last year. IPD at the beginning of the year posted UK commercial real estate market returns of 14.5% for 2010, compared with 2.5% the previous year. Although capital values increased by 6.9% as a result of yield compression, the upward trend had more or less run its course by mid-year. Income, in contrast, was down from 2009: 7.1% compared with 8.2% the previous year.
What emerged strongly from the IPD report was the dislocation between London and the rest of the UK market, with the capital driving performance. That trend is likely to increase as a result of austerity measures.
This doesn't seem to be a UK-specific phenomenon. According to the 2011 edition of Emerging Trends in Real Estate Europe, a report published annually by PWC and the Urban Land Institute, the industry is seeing the development of a two-speed Europe, with the gap widening between prime regions and areas outside prime, even within the same country.
Jeremy Marsh, director of research and strategy at Invista, claims income will remain a significant factor in UK commercial property returns through 2011, with values falling still further for secondary. The fund manager sees current government spending cuts reducing demand for office and retail space significantly, especially in secondary regions.
There are still pension fund buyers for non-London, regional and provincial office assets. The West Sussex local authority pension fund, for example, recently acquired for £5.9m (€6.8m) an office block in Egham, Surrey, with Blackberry developer Research in Motion as a tenant on a lease due for review in 2016.
But for the time being, buyers are here mainly for prime assets. There have been some significant deals executed by pension funds over the past year, not least of peripheral assets related to the Olympics in 2012. Take last year's €1bn acquisition of Westfield Stratford City's retail component by APG, the €250bn manager of Dutch pension scheme ABP, and the CA$139bn (€100bn) Canada Pension Plan Investment Board (CPPIB).
Some investors have specifically targeted the UK. Not only does it sit outside the euro-zone, it also offers investors well-structured governance. Others are investing in the UK but, as it were, by chance - such as pension fund manager PGGM, which has invested £220m in UK social infrastructure via a fund with Lend Lease. "We weren't focusing on UK assets exclusively but the opportunity came up with Lend Lease in the most developed country for PPP," says Henk Huizing, head of infrastructure at the €109bn Dutch pensions provider, which manages assets for the €99bn PFZW healthcare scheme.
Yet even if there's traction left in prime, Marsh suggests yield margins in central London and the West End will be thin. "People should be asking: are we there yet?" he says. "That's why were bearish for this year. I haven't quite gauged how 2011 is going yet. There is evidence that people are still looking for quality assets. But there won't be a strong bounce-back in rental values for two or three years. This will be a crucial year for the economy and for property."
Other investors, believing prime is fully priced, are looking to secondary for value. Among them are Richardson and Rachel McIsaac, asset management director at AEW UK. "The gap between prime and secondary yields is the largest in 15 years. That presents an opportunity for investors," says McIsaac. "You'll see a yield shift in the next few years but now it feels very similar to 1993 and it's exciting to be in that position again. You have good property but nervous sentiment. With secondary, you have yield shift potential and income. What's not to like?"
It isn't just the UK, either. Richardson claims we'll see yield compression in secondary within 18 months, just as we're already seeing yield compression in prime real estate in Paris and Stockholm. Then investors' attention will turn to second and third cities such as Lyons, Lille and Gothenberg.
"My argument is simple. I never want to buy when things are expensive," he says. "Prices are never crazy: they're what someone is willing to pay. But I'm not looking price, I'm looking at value."
In any case, if the UK looks to overseas investors like a safe haven, Stockholm is edging up on it. Many recent transactions in that market have involved domestic players (and prime). In December, for example, a property company owned by the first, the second, third and fourth national pension funds added to its existing SEK70.7bn (€8bn) assets under management a Stockholm block acquired for €483m in the market's largest single transaction to date. The acquisition came just weeks after Swedish pension group AMF acquired a mixed-use complex in the same district, reportedly for €300m.
In fact, according to the European Association for Investors in Non-listed Real Estate Vehicles (INREV)'s 2011 investment intentions survey, Germany, France, and the Nordic states all came out ahead of the UK, which came out top the previous year. The shift reflects a slow economic recovery and higher property prices in the UK.
So what of the longer term? For overseas investors, it has much to recommend it, as Peter Reilly, managing director of JPMorgan Asset Management, points out - not least tax efficiency, in contrast with France and Germany.
"Of the international capitals of the world — Hong Kong, New York, London — London dominates financial services," he adds. "But as a result of this reliance, the market tends to be much more volatile. I wouldn't say I prefer one city to another but it makes sense to invest at a different point in the cycle and at different risk levels."
When European pension funds are thinking of moving outside their home countries, the UK tops the list of likely destinations. If they're going direct, it still features high up. If the market is uncertain at home - as Spain, Ireland and Russia are - the UK is seen as a safe haven.
"It's dynamic. It's diverse. It's probably the most liquid market in the world," says Andrew Hynard, chairman of JLL's UK business. "It consistently appears in the top three investment destinations along with the US. But compare it with the US in terms of GDP and population. It punches well above its weight," he adds.
The problem is that in the long term it is competing with China and other Asian emerging markets. Your local school basketball champions might put in an exceptional game, but against the Harlem Globetrotters they don't stand a chance.