June 14, 2016
The UK investment market has been noticeably quieter in the past few months, with transaction volumes down almost 30% year-on-year.
The popular explanation for the slowdown has been that the market is waiting to see the result of the referendum on the UK’s EU membership. The suggestion is that if the UK votes to stay in, it will release the brake and we will see a very busy second half of the year, whereas a vote to leave will bring a period of continuing uncertainty and a likely pricing correction before a recovery starts properly in 2017.
This is a view that I would challenge, not because of my views on “in” or “out”, but because the assumption that Brexit is the sole reason for the markets pausing is probably wrong.
The UK has experienced a strong run across the property sector over the past four years, both in terms of values and transaction volumes. In the second half of 2015 activity started to slow, something that has continued in 2016. It is always hard to evidence when you are near the peak of a cycle, but this may be the case.
By way of example, Palmer Capital sold two of the largest single assets it owned in March 2016, totalling approximately £100m. On both we found the marketing produced one stand-out buyer, with a gap before the rest of the pack, which was reduced in number and below our valuations. Despite the obvious view that you only need one buyer to succeed, this thinning of demand eventually affects pricing in the market, as it only takes one buyer to withdraw before the transaction evidence shows the falling of capital values.
The next question is why are the markets slowing, if not because of the UK referendum? In recent years the investment markets have been disproportionately driven by overseas investors. Over the past year they have been hit by increases in SDLT on both commercial and residential, a property development tax on overseas buyers, and increased scrutiny of offshore tax-driven structures. Even though a weaker currency has worked in their favour recently, the net returns are falling.
Those investors that are buying into bond proxies from long-dated investments rightly remain comfortable with the falling financing rates offsetting taxes, but buyers of trophy assets in gateway cities, and the opportunistic buyers, are becoming more cautious globally, with reduced liquidity reducing confidence to buy.
This caution is compounded by the fact that quantitative easing is now largely finished, other than in the eurozone; UK pension funds are maturing and becoming more income-focused; and the commodities boom is well and truly over. The result is a wide-ranging reduction in the appetite for risk assets, which is pushing down capital values and is unlikely to change, regardless of political squabbles in the UK.
With rising replacement costs and reasonable levels of demand, offices and logistics rents still look low and affordable for occupiers. While the UK has too many offices, which are depreciating faster and faster, demand remains for the right product in the right urban location.
The UK population is also continuing to grow, regardless of new immigration, driven by higher birth rates from people who settled here over the past 20 years. Against this, the supply of housing remains woefully short of anything near the demand. So the outlook for sectors driven by demographics, such as residential, and lower-risk bond-like assets look fine to us. For this reason, regardless of whether we vote to leave the EU or not, we continue to advise our clients to move to either end of the risk spectrum, buying either non-correlated opportunistic assets, such as brownfield land that can be turned into residential, or to buy bond proxies, both of which are less correlated to property cycles.
The best news, if I am right, is that whichever way you choose to vote in the referendum, you won’t need to blame yourself. It is likely that outside those few relatively attractive parts of the market, a recovery will not be driven by your vote, but by what happens globally to economies that have previously invested into the UK.
Whichever way we vote, the world keeps on turning, and our industry is a small cog in the bigger economic wheel. So while there are some who believe we can operate successfully as an island, I believe we are entirely coupled to global forces which have a far greater impact on our domestic real estate market than we sometimes understand.
Author: Alex Price, CEO at Palmer Capital
Link: http://www.egi.co.uk/news/uk-investment-market-quietens-down/%3Fkeyword=alexprice