UK property markets have been very much a two tiered affair for many years now with growth in London and the South-East outpacing the rest of the country across residential and commercial markets. However with momentum stalling this trend may be set to reverse.
Within residential markets the acceleration of house price growth is seemingly over. Prices in London in particular are beginning to be curtailed by affordability pressures. This can be seen in transactional volumes which now sit at their lowest level since 2013 and there is widespread expectation of further declines. New sale instructions have now been negative for fifteen months in a row. This is bad news for estate agents and is reflected in share price declines of notable companies such as Foxtons. Recent tax changes have also shifted focus of investors into the higher yielding lower value markets and this creates further headwinds for price rises of any significance within prime markets.
Income will continue to be the prime driver of returns on commercial property and certain sectors will undoubtedly fare better than others. Within the retail sector ongoing technological disruption creates a challenging environment, but the decline of the high street creates opportunities elsewhere. The logistics sector is enjoying an expansion and investor demand can be seen through well supported recent new issuance in the investment company sector. Pacific Industrial REIT has raised additional capital recently and Warehouse REIT will be undertaking an IPO in mid-September seeking to raise £150m.
It seems nigh on impossible currently to comment on any UK industry without reference to Brexit. Undoubtedly this has significant potential to negatively impact upon broader UK property markets. It should come as little surprise that London offices are the most vulnerable to inconclusive and stalling news flow from the Brussels negotiating table. However, looking through the politics, the key to understanding the extent to which Brexit may curtail demand is to look at corporate strategy. There have already been tentative signs that financial services job losses in the City could be significant. Deutsche Bank recently announced an expectation of 4,000 jobs moving to the EU after Brexit As further plans emerge we can expect this to exert some downside pressure on rental yields in the capital.
Nonetheless we have seen a number of trophy assets purchased recently, notably the ‘Walkie Talkie’ and ‘Cheesegrater’ buildings, both of which were sold to Chinese investors at values in excess of £1bn. Undoubtedly the decline in the value of Sterling has been an offset to any perceived weakness in UK markets making assets relatively more affordable. Whilst these trophy purchases grab headlines, they potentially mask an undercurrent of weakness.
However there are bright areas within the softening property market. Alongside the opportunities in the logistics sector, other specialist areas within the UK market retain scope for further growth. Areas we favour are social housing, student property and healthcare, all of which have supportive fundamentals and exhibit low economic sensitivity. Within the TMI Diversified Assets Fund (which currently has a 15% exposure to property markets) this view is reflected via a range of real estate investment trusts (REITs). REITs we are currently invested in include Tritax Big Box REIT (Logistics), Primary Health Properties (Healthcare), Empiric Student Property (Student Property) and Civitas Social Housing (Social Housing), all of which have delivered excellent returns over the year to date.
Many commentators have suggested that the impact of Brexit may be overstated and whilst this may be true, the importance of stock and sector selection within property markets cannot be understated. Investor demand for income may provide support at an aggregate level but avoiding exposure to those areas with the most vulnerability will prove essential in generating positive return for investors.
Head of Alternatives Research and Senior Portfolio Manager
Commentary first appeared in:
What Investment - A select Portfolio (in print on 1st October 2017)