UK Property Market Outlook

21/10/2016

The UK commercial property market has been more resilient than we expected immediately following June’s vote to ‘Leave’ the European Union (EU). Property transactions have recovered since the aftermath of the referendum result, with £9.4 billion of assets sold in the third quarter, between July and September.

The weakening of the UK pound, whose value has fallen sharply relative to other major currencies since the surprise vote, has been important. By making UK property less expensive, in relative terms, the pound’s weakness has encouraged overseas buyers, who accounted for 45% of asset purchases (by value) in this three-month period.

Acquisitions by existing tenants are up from the same period in 2015, also supporting demand. Most significantly, the US bank Wells Fargo bought an office building in the City of London for its European headquarters.

Our pessimistic outlook for the office sector has softened marginally since July. In particular, we believe the market for offices in Central London will be more resilient than first thought, although it is likely to suffer the greatest fallout from the Brexit vote. With uncertainty about the settlement that the UK and the EU will ultimately reach, the scale of any relocation of London’s overseas-based financial institutions to elsewhere in Europe remains unclear. In any event, the fund’s largest asset in Central London is Riverside House, whose tenant is the UK telecoms regulator Ofcom.

The commercial property market is much broader than offices, and we believe other sectors represented across our portfolio – especially industrial – should perform better in the near turn.

In our view, industrial property values will be supported by a lack of supply of quality assets. There is strong demand from retailers for smaller warehouses close to towns, as online shoppers demand tighter delivery windows, while larger warehouses are still required for regional and national distribution of goods.

The retail sector has been surprisingly resilient since the ‘Leave’ vote, with most businesses sticking to their rental plans for 2017. We believe rental growth is likely to be muted going forward, however, given the economic uncertainties that accompany the run-up to Brexit.

Encouragingly, the fund’s retail portfolio has a diverse tenant base and a very low vacancy rate, of roughly 1%. Nevertheless, it remains to be seen whether UK consumer confidence will be materially dented by the fall in the value of the pound, and how much higher inflation – which is widely expected to continue to rise – will affect demand. In our opinion, many of the fundamentals that underpin the UK commercial property market are still reasonably solid. Compared to the market’s last downturn, during the global financial crisis, there is much less evidence of oversupply in the market, and tenant demand today is also stronger. Importantly, strong demand for commercial property in the run-up to the EU referendum was predominantly fuelled by equity rather than by debt, unlike before the financial crisis.

In the immediate aftermath of the surprise ‘Leave’ vote, M&G Real Estate forecast a UK commercial property negative total return of 6.4% over the 12-month period to June 2017. While we have seen capital values fall 4% in the third quarter of 2016, property values now appear to be stabilising.

Our view today is somewhat less pessimistic and our provisional forecasts have been tempered. Property values are expected to fall further in the final quarter of the year, with capital values cumulatively falling by 4.5% in 2016. Once rental income is included, total returns for UK commercial property are forecast to be 0.1% for 2016.

We expect capital values to decline further in 2017, resulting in a projected total return of 2.7%. This figure reflects a less dramatic fall in property valuations, and includes the stable returns from rental income.

Taking all this into account, we feel that property prices have not yet fully corrected. Given the uncharted territory ahead, we do not rule out further periods of weakness going forward, particularly as ‘Brexit’ negotiations begin. The value of investments will fluctuate, which will cause fund prices to fall, as well as rise, and you may not get back the original amount you invested.

 

The value of investments will fluctuate, which will cause fund prices to fall, as well as rise, and you may not get back the original amount you invested.

The views expressed in this section should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.