October 12, 2016
The summer always provides an opportunity to pause and reflect on the market and to take stock of what this means for the rest of the year.
I reached the conclusion that Brexit will have a big short-term impact but will not change the long-term fundamentals for UK real estate, both threats and opportunities, although it may accelerate changes. I also decided that the explanation of “Brexit means Brexit” does not help with understanding what the outcome will be, but that it will take at least three years to know this, and more likely more than five years.
Population growth is not creating per capita wealth, in fact inequality is growing in the UK, with the poorest 50% of society having less than 9% of the wealth and the richest 10% having just under 50% of the wealth (in the US this figure is 70%). The majority of voters are left feeling disenfranchised by the system, creating space for radical ideas to germinate and potentially reducing social cohesion. Secondly, we think that government indebtedness will continue to dominate its policies, leaving little room for budgetary manoeuvre and a desire to stimulate inflation.
Finally, we think improving technology in artificial intelligence, online connectivity and robotics will dramatically change the employment market and the utilisation of real estate. We can already see some changes to UK car manufacturing (better robots), logistics (driverless vehicles) and call centres (tomorrow’s AI datacentres). It will not be long until lawyers and bankers are also challenged by AI, and the virtual reality meeting becomes standard. These threats will lead to less demand for office space, less retail space, new logistics chains, and fewer low-skilled jobs.
However, opportunities always exist in times of change. Governments will keep interest rates low for a long time, creating an opportunity for investors to continue to buy assets with the UK’s highly attractive long-term, inflation-linked FRI leases to well-capitalised companies. Combined with record-breaking long-term swap rates, if you use leverage, returns will be far better than bonds can provide.
Pension funds have growing liabilities and need to achieve returns that are far better than bonds can do in the medium term. The trustees face a decision between defaulting on the liabilities or moving up the risk/return spectrum into real assets. This will sustain and may even drive values in the investment market, especially for better quality assets with lower depreciation.
Secondly, underlying demographics will help real asset investors, as UK population growth is being driven as much by birth rate as EU migration, even though the latter gets the headlines.
We do not have enough infrastructure and accommodation for today’s population, let alone tomorrow’s. Even if people cannot afford to buy residential assets, they will need to rent somewhere to live.
This means an increasing number of redundant commercial properties, usually located in urban areas, will be used for residential – driven by government showing it is supporting the needs of an already dislocated electorate.
With all of the political uncertainty in the UK, any investment strategy in 2017 will require flexibility, but we believe that short-term flexibility should not replace the need for a long-term view. The changes we are seeing, and the changes we expect to see, provide an opportunity for the industry to prosper and we should seize them, as we live in exciting times.
Regardless of what Brexit means or how you voted in June, we need to make a success of it by firing up the entrepreneurial spirit in our industry to create new solutions and fresh ideas that drive the political agenda.
Author: Alex Price, CEO at Palmer Capital
Originally published in Estates Gazette on 1st October 2016
Link: http://www.egi.co.uk/news/investment-outlook-into-2017/