With a new Conservative government enjoying a majority in parliament and the passing of Brexit withdrawal bill, all eyes are on what will happen to the UK real estate market in 2020.
Expectations are for a departure from the EU at the end of January. Will this finally spring the country’s commercial property back to life?
According to Will Matthews at Knight Frank, business is always looking for certainty and the conservative majority in the general election will create a more certain environment, with the UK more likely to leave the EU early next year.
“We might then witness a flurry of activity at the start of the year, as there is a great deal of pent up demand for commercial real estate that just needs a bit of certainty to be realised, Matthews who heads the head of UK commercial research says.
This is contingent on the right assets being available, and investors seeing the value in them. It will also rest on investors being willing to sell – ultimately a ‘Catch 22’ scenario, he says.
Matthews adds that investors might be reluctant to sell as there is nowhere to put their money in the aftermath, and subsequently there may be fewer assets up for sale.
“We’re yet to see the anticipated large scale relocation of major companies to other parts of Europe materialise.”
US private equity funds are the currently the largest source of capital, though not all of them are squarely focused on the UK, Matthews says.
“The main trend we’re seeing now is the sheer diversity of sources, with investors more willing to go for different asset classes, whereas in the past some asset classes were more institutional in nature.
“The Middle East is likely to be a short-term source, whilst China’s renewed government policy will set it up for growth in the longer term. Similarly, Japan is gearing up for a great deal of investment activity in 2020.
Matthews believes London will be the next big opportunity. The “market peaked in 2015” and has been in a holding pattern ever since, he says.
“There are already signs of investor confidence in the city; more than 300,000 jobs have been created over the past four to five years, and we estimate a total of £55bn (€65m) is waiting in the wings as unspent financial firepower.
”That figure has doubled since 2016, and investors will no doubt be watching it in 2020 with a renewed eagerness.”
Jessica Berney, the fund manager of the Schroder Real Estate Fund (SREF), says Schroders expects the commercial real estate market in the UK to remain strong in 2020, despite some investor and occupier hesitancy as a result of Brexit and the slowdown in economic activity.
Berney says a “potential Brexit deal could trigger a new inflow of foreign capital, particularly into the London office market, where yields remain higher than Paris and Berlin.
“Meanwhile the weakness of sterling may also attract investors from the likes of South Korea, Japan and the Middle East in particular.”
Another ‘tricky year’ for retail
Berney says Schroder is seeing the demand for lightweight industrial space growing and, aligned with this, self-storage is increasing in popularity.
“Initially this growth was in line with demographic trends, where demand is being driven by changing occupancy patterns,” she says. “However, we are also seeing increased demand from the online-seller market for self-storage space, where this flexible storage solution is being used to grow businesses without having to commit to large storage options.
“Demand for high-quality and flexible-office space continues apace, and we don’t anticipate this changing during 2020.”
Chris Taylor, the head of private markets at Hermes Investment Management, continues to remain cautious about the level of real estate pricing in “absolute terms – given the continued profound structural changes affecting the fundamentals of occupational demand”.
He adds: ”For many investors, of course, the positive yield gap between real estate and bonds continues to support the investment case for relative value, which has arguably created a real-assets bubble.
“However, we are already witnessing outward yield movement across the retail sector as the underlying occupiers continue to face fixed overheads with no real-wage inflation to support sales growth and further leakage of sales online; technology, urbanisation, demographic lifestyle trends and an increasing awareness of climate and environmental risks are all affecting how occupiers behave across all sectors of the real estate market.”
Taylor expects to see “further capital declines across the retail sector in particular, as much of the existing space is no longer relevant”, and argues that “those managers which address the fundamental drivers of income and have integrated ESG within their analysis should outperform”.
Similarly, Berney says retail may have another tricky year, but retail centres can “still thrive if the right investment opportunities are targeted”, she says – particularly those that benefit from structural growth drivers, such as rapid urbanisation, technology and demographics.
Greg Kane, head of European investment research at PGIM Real Estate, says that, despite ongoing concerns about the outlook for global economic growth and a weakness in cross-border capital flows, performance of the global real estate market in 2020 is set to be supported by a number of important factors.
“The demand side continues to enjoy support from employment growth, which is coming up against still-low supply growth,” he says. “Meanwhile, a reversal of course among major central banks towards looser monetary policy and lower interest rates is set to result in further yield compression.
“In absence of a more pronounced economic downturn, real estate markets look set to deliver another year of decent, if not spectacular, returns in 2020. However, as always, real estate dynamics vary quite significantly by geography.”
Central banks give European real estate an extended stay
Looking at Europe more broadly, a report by AEW shows that, despite worsening global economic growth and business confidence, the outlook for European property has improved.
The report states that, as “political uncertainty dominates global news headlines, business confidence and economic growth appear to be trending down”, but central banks’ policies are expected to keep rates lower for longer.
These lower for longer yields are “good news for commercial property values with AEW’s latest risk-adjusted return approach identifying 80 of the 100 covered markets as attractive or neutral”.
AEW says this benign overall outlook allows for a renewed focus on adoption of ESG processes and reporting procedures, as the traditional cyclical risks of excessive new supply and use of debt remain low.
Rob Wilkinson, European CEO of AEW, says: “After the recent central bank policy reversals, the lower-for-longer scenario has now become our base and, perhaps counter-intuitively, this can mean good news for real estate investors.
“With bond and property yields expected to remain at current levels for some time to come, strong competition for deals will continue. For those with an intimate on-the-ground knowledge of specific markets, value can still very much be found, often in places that might seem out of favour, although stock selection remains crucial.”
Hans Vrensen, head of research and strategy at AEW in Europe, adds that, as the European property market cycle is extended, the sector can focus on adopting the latest best practice ESG processes and reporting procedures, especially on the building level.
“This is consistent with our positive market outlook, as the usual cyclical risks of excessive new supply of space and use of debt are now less of a concern. We could call it the calm before the storm – with no clouds on the horizon yet.”
ESG and impact investment are sure to have an even greater significance across real estate in 2020, Berney adds.
“Occupiers are a lot more aware of climate change and as such we have already seen an increase in demand for space with good sustainability credentials, and health and wellbeing considerations at the core.
“These aspects - from acquisition through to asset management – have never been more relevant in ensuring that our tenants have the best experience possible and that our buildings are fit for purpose for years to come.”