UK market to revert to fundamentals in 2016 - Savills

The UK real estate market will go back to fundamentals in 2016 with average total returns on commercial property investments slowing to 7.5% and the strong capital value growth story of recent years starting to wane, according to Savills research.

'There will be an increasing focus on asset management, refurbishment, development and rental growth,’ said Mat Oakley, head of commercial research at Savills. ‘Investors will look for positive trends that deliver income, and will shift to markets beyond London.’

In 2015 UK commercial property delivered returns of between 15% and 20%, leading to another year of record-breaking investment activity at £70 bn (€97 bn). In 2016, as slowing capital growth leads to diminishing total returns, investment volumes may begin to slow to £60 bn, although they will remain ahead of the long-term average. There may be also be a re-weighting from commercial property to other asset classes, especially when sovereign bond yields, as expected, start to rise.

2016 is shaping up to be a very different year, but will still be ‘opportunity-rich’, Oakley said. His top three picks for the commercial property sector in 2016 are, firstly: office refurbishment and development in the big seven regional cities and fringe areas, which are expected to experience stronger than average rental growth, reaching ‘London levels’, as the ‘Northshoring’ of jobs, the shift to cheaper locations outside the capital, continues.

The second is central London retail, which will deliver 6% returns, not so much core streets like Bond Street but emerging luxury submarkets around the traditional shopping areas. The third pick is core logistics and industrial, with steady rental growth expected everywhere. The biggest play is multi-let industrial estates in the South of England where the new permitted development rights will facilitate conversion.

Conversion of Industrial to resi
Demand for residential property in and around London is such that the conversion of industrial estates to resi is emerging as a new trend, according to Oakley. One example is the Old Nestlé Factory in Hayes, sold to Segro earlier this year, which will become a mixed residential-warehouse development. ‘There is great competition for assets anywhere south of Oxford and the big four logistics operators will do increasingly creative land deals, acting as facilitators of urban regeneration,’ he said.

Looking ahead, the greatest threat to UK real estate is the referendum on membership of the EU, which must be held by 2017 but for which no date has yet been set. Opinion polls point to a very close result, and a possible ‘Brexit’ would have far-reaching implications for real estate in general and for the office sector in particular.

‘International investors are spectacularly relaxed about the EU referendum,’ Oakley said. ‘They invest for the fundamentals of the property market and because they see the UK as one of the least risky domains in the world, not beacause it is in the EU.’

The biggest danger is a long period of market stagnation or cessation of activity due to uncertainty: ‘Investors will be worried about making the wrong decisions and the referendum provides an easy reason not to sign a deal or not to commit to a deal,’ he pointed out. ‘It could be very quiet in the transactional market. This is why the months before the vote will be worse than the aftermath, whatever the outcome.’