A question of risk & return
6 December 2016, by Mark Ridley
Political and economic uncertainties will dictate the patterns of property investment over the next five years
When we prepared our cross sector outlook last year, few would have forecast that 12 months later the UK would have voted to leave the EU – prompting a change in leadership of the country – and that Donald Trump would have become president-elect in the US.
Though not nearly on the scale of the global financial crisis, these events have heralded much greater domestic uncertainty on both political and economic fronts.
At a macro level this means more caution and risk aversion among investors. This is expected to reduce the prospects for capital growth across all three sectors.
It means more secure income streams will become more highly prized among core investors. This plays towards the UK long commercial leases where the rental covenant is strongest. For the same reason we expect the momentum for investment into large residential portfolios to continue to grow among institutions.
Risk premiums are likely to increase. This is likely to push commercial yields out slightly in the short term, presenting investment opportunities, particularly given the low returns available from sovereign bonds and cash.
The changed attitude to risk is likely to mean a less crowded market place for the value-add investor, particularly if lender caution results in tighter borrowing criteria in the development sector. Greater risk will mean a strong focus on sectors where the fundamentals of supply and demand are most insulated such as retirement housing, logistics and energy.
For opportunistic investors the continuation of the ultra low interest rate environment is likely to limit the extent to which distressed assets hit the market. This is likely to mean they look instead to the development markets, particularly mixed use opportunities linked to infrastructure improvements.
Against this overarching picture, there are a number of sector specific factors, that will influence the pattern of investment in the run up to and immediate aftermath of Brexit.
Source: Savills Research
In the commercial market the position of London as a global financial centre will be under close scrutiny. The comparative costs of staffing and office space among the pretenders to London’s crown are likely to protect it from any fall out.
Though we expect to see a downturn in office leasing activity in the capital, this is likely to be offset by a fall in development activity that will limit new supply coming to the market to support rents.
Elsewhere in the office market, we expect lack of dependence on cross-border financial services, low supply, and a very restrained development pipeline to support the major regional city office markets.
In the retail market, while some investors remain concerned about the impact of the internet on traditional retail, most retailers are now fully entrenched in an omnichannel world. Our rule of thumb for the best buys in retail is to make sure it offers shopper experience, or convenience.
Logistics property will remain highly sought after, due to its long and often indexed leases, as well as the landlord-friendly dynamics in the occupational market.
In the residential market it is the indirect implications of the Brexit vote that hold the key. The changes in government have led to a shift in housing policy, with a much greater emphasis on delivering more housing across a much wider range of tenures.
This means greater opportunity to unlock development potential of strategic land for the opportunists and value-adders. For the core investors, who have gained more traction in the Build to Rent sector, it is likely to mean a more accommodating policy backdrop.
By contrast, private buy to let investors face a combination of higher stamp duty costs, less income tax relief and greater mortgage regulation. This is likely to mean a continued imbalance between supply and demand in the private rented sector that pushes up rents.
In contrast to the commercial sector that is likely to marginally improve income yields. Debt backed private investors, faced by these challenges, are increasingly likely to look to higher yielding, lower value markets to deliver cash returns.
Taxation is also likely to be a key driver in the prime housing markets, where stamp duty rates are highest. Overseas investors also face higher exposure to capital taxes, which is likely to mean that they will want to be confident that residential investments offer value in sterling terms, irrespective of a potential currency play.
In the rural sector, the £3 billion of subsidies provided by the Common Agricultural Policy each year can no longer be guaranteed to underpin farm incomes over the longer term. They are, however, secure until 2020 and in the short term, the depreciation of sterling will boost their value in sterling; underpinning demand for farmland.
Over the longer term, they are likely to be gradually eroded and increasingly weighted away from production towards public goods such as the environment.
This means that buyers will increasingly differentiate between the underlying commercial value of farmland, its amenity value and, in the case of strategic land, its development potential.
With 60% of UK food exports worth £20 billion going to the EU and 17% in addition going to the US, the first impact on farming incomes will be dictated by the trade deals that are struck. This is likely to mean diversified income streams will be an increasingly important hedge on those farms occupying the middle ground.
Source: Savills Research
Receive the latest research
Chief Executive Officer
Savills UK & Europe
Savills Margaret Street
+44 (0) 20 7499 8644