March 31, 2016
The recent Purchasing Managers’ Index survey for the UK service sector suggests that, against the backdrop of a global slowdown and looming Brexit referendum, the UK economy has softened.
Inevitably, investment decisions may be deferred and domestic institutional investment activity is likely to remain muted until the summer.
Depending on the outcome of Brexit, it could be a very busy Q3 or potentially an extended period of uncertainty while we try to agree what the future looks like. So the question we have been asking ourselves is: where do we find the best risk-adjusted returns in this environment? We think that alternative assets, and in particular residential, may provide some answers.
The Investment Property Forum estimates the total size of the UK commercial real estate market is now about £750bn. The alternative sector, which includes an array of sub-sectors from students to healthcare, accounted for about 9% of the UK market by value in 2010. JLL estimates this will rise to about 29% by 2019, and this rapid growth begs the question as to whether it is still “alternative” or now mainstream.
Indeed, the UK residential sector, valued at more than £5tn, dwarfs the commercial sector, and within this, the private rental sector is about £850bn, which is bigger than the “mainstream”.
As the sector grows, so our international investors (Middle East, Thai and Japanese, in particular) are taking advantage of a weak sterling to target the longer-dated income returns provided by assets such as pubs, schools and data centres. These investments offer inflation-hedged cash flows and lower correlation to other commercial assets, making them attractive to our UK pension fund investor base as well.
We also think that the new accounting regulations coming into force will make longer leases less and less attractive for occupiers of business space. Long-date income will be increasingly hard to find, with potential pricing pressure as a result.
Real estate tends to benefit from two characteristics – economic growth and demographic growth. Commercial is normally skewed to the economy, while alternatives such as residential, infrastructure and schools are more heavily skewed to demographics. Today, as we stare into the Brexit void, it is likely that the economy will suffer regardless of the vote, whereas the demographics continue an inexorable trend upwards. Even leaving aside the sensitive issue of immigration, the UK is set to see its population grow from 65m to 77m in the next 35 years.
Given this, it is no surprise that investors are openly embracing the residential sector and not just in terms of income-orientated private rental housing, but also asking whether the sector offers an alpha opportunity. Across the UK, residential demand is accelerating house prices, particularly when set against an undersupply of suitable land and shortage of construction capacity.
We therefore continue to see an opportunity to obtain capital growth from residential by enhancing the value of land, particularly brownfield sites, through the planning process. This allows us to provide house builders across the UK with oven-ready sites where they can “plug and play”.
So our tip to leap over the void is to look at alternative real estate assets to deliver both the income return that investors increasingly need, and potential alpha as residential becomes more institutionally acceptable.
Excellent returns can be achieved through the creation of assets (acquiring land and obtaining planning) through to the management of long-dated or inflation-hedged operational income (predominantly in the private rented sector). Don’t wait for June – the opportunity is already here.
Author: Alex Price, CEO at Palmer Capital
Link: http://www.egi.co.uk/news/financial-comment-where-are-the-best-returns/%3Fkeyword=alexprice