As the current favourable spread with bond yields won’t last forever, value from the record low initial yields seen across Europe can only be achieved through income growth from strong occupational fundamentals, says Thomas Wels, head of REPM at UBS Asset Management.
Which trends and developments do you hope for most for your business/sector?
We are expecting that 2018 will be a year of relative stability for the real estate sector, as there is limited opportunity for further yield compression but at the same time we don’t see a catalyst for repricing of assets. As the current favourable spread with bond yields can’t be relied on forever, value from the record low initial yields we’re seeing across Europe can only be achieved through building income growth from strong occupational fundamentals. We hope to continue seeking out investment opportunities that offer this attractive component.
What do you fear the most in the coming year in terms of impact on your business?
The biggest challenge for 2018 will be deployment of capital. There is simply too much money trying to access the limited supply of core real estate stock in Europe, so investors are either faced with paying steep prices or looking towards more secondary assets and markets. In this environment it is more important than ever to think about fundamentals as we look to deploy capital without chasing yield by going to locations we should be avoiding or by overpaying for assets which don’t have a strong enough growth story to justify the low entry point. Political noise will undoubtedly continue in the background but as 2017 has illustrated market fundamentals generally beat uncertainty.
Will you be expanding or scaling down your business in 2018?
We intend to continue on an upward trajectory in terms of investment, focussing on the markets and sectors where we identify the most attractive growth prospects for different strategies supported by significant capital commitments.
In many core European markets, income growth potential has already been fully priced in, although we still see opportunities to expand our portfolio through selective value-add investments. We will also look at cities which have a very positive macro-story on the occupational side. However, as we head into the late-cycle phase, it will be increasingly important to constantly evaluate risks, and in particular which markets and sectors might be most exposed to a change in monetary policy.
What is set to have the biggest impact on your business?
Interest rates, Brexit, technology and geopolitics will all, to an extent, have an impact. Whilst it is difficult to say the Brexit process is going well, the negative impact of the uncertainty and confusion on the UK property market seems to have been fairly muted. Perhaps the key takeaway is that the effect of political uncertainty on real estate markets can be overstated. Investors’ motivations should also be considered and on a relative basis – for example, a lot of the money which has supported the UK this year has come from countries with political situations that dwarf Brexit, and if investors are looking at a longer term horizon and income security the potential short-term volatility is a relatively minor concern. As has been the case for several years, with interest rates and returns on fixed income remaining at such low levels, core real estate continues to offer an attractive spread to other asset classes and whilst that remains in place it’s difficult to see any significant outward yield shift in 2018, even if we don’t see the same sort of levels of yield compression that has boosted returns in 2017.
What will trigger the next downturn in real estate?
It’s unlikely that we will ever see another downturn of the scale of the GFC, as the industry operates much more prudently as a result of capital constraints. Development activity in the commercial real estate sector remains and is expected to stay significantly below pre-crisis levels. As with most historic downturns, the triggers were impossible to predict. There are, however, independent concerns on a country-by-country basis, whether that be oversupply, monetary policy or political risks.
