The impending vote on EU membership is one of several risks that could affect UK real estate returns this year, according to Richard Levis, global real estate analyst at Aviva Investors.
The impending vote on EU membership is one of several risks that could affect UK real estate returns this year, according to Richard Levis, global real estate analyst at Aviva Investors.
Other potential downside risks include a renewed eurozone debt crisis and faster than expected interest rate increases, he added.
'We expect healthy occupier demand and a broader recovery in the rental market to drive capital appreciation in coming months. Good quality, higher-yielding assets are likely to do especially well this year, but there are multiple risk factors that could have both negative and positive implications for the market,' he said.
Levis said he doubted whether the UK electorate would vote to leave the EU this year. 'However, short of a decisive mandate to remain in the EU, the aftermath of the vote could see unusually high currency volatility, higher gilt yields, capital flight, weaker economic growth and another Scottish referendum. All of this could drain liquidity and damage investment performance of UK real estate in the short-term,' he noted.
Even if a Brexit should eventuate, the UK will probably retain extremely close economic and political ties with the EU, he added. 'Hence, longer-term impact would depend on the outcome of trade negotiations between the two parties. A UK exit would put the central London office market most at risk within the commercial occupier sector. London’s financial district is especially vulnerable due to a potential drop in demand for buildings from the financial services industry.'
Greece
While the fragile political situation in Greece could provoke a re-run of the 2011/12 debt crisis and renewed fears that the euro project could be derailed, Levis said the impact on UK real estate would vary according to how a subsequent crisis was to unfold. 'But,' he added, 'the economic outlook would weaken, and confidence in the market would fall.'
Aviva's central view is for UK interest rates to remain extremely low in 2016, rising at a gentle pace in coming years and peaking below their pre-2008 historical norms, he said. 'But unexpectedly rapid policy tightening would savage real estate returns if property yields also rose rapidly.'
Levis pointed out that rental growth in UK real estate is currently at levels not seen since the last cyclical peak. 'Our central case is that we expect it to cool this year as the central London office market slows. Yet, there is a possibility rents will surge on restrained supply, low vacancy rates, a lack of new development and steady economic expansion.'
The biggest upside potential, Levis said, is in the industrial sector, which has not had much real term rental growth since the late 1990s.
Levis expects overseas net investment to ease this year amid slowing emerging economies, heightened geopolitical tensions and low oil prices. 'But,' he added, 'we can also envisage an upside scenario where overseas net-investment continues to rise and, as a result, yields for the best quality assets would fall further. In addition, demand for lower quality secondary assets and strategies would rise fuelling a further “re-rating” of secondary yields. This scenario would also put further pressure on investors to increase exposure to non-core real estate assets such as infrastructure, residential, healthcare, care homes and leisure.'