Investment View November/December 2014
The last few weeks has seen a substantial recovery across markets following the sell off that started in mid September. Markets were fearful of Europe falling into recession and talk of a Japanese “lost decade” was being mused. Words from Mario Draghi hinting at further stimulus from the European Central Bank and unrelated unexpected positive action from Japan’s central bank provided sufficient comfort for markets to pick themselves up and make up the lost ground. Whilst the US seems to be growing from strength to strength, Europe continues to struggle so the concerns are parked for the moment on the belief that action will be taken if necessary. Europe will be a key area to watch in 2015 and may provide some interesting opportunities.
The previous Investment View had intended to take a look at the property sector, which features in almost every portfolio that we manage but market events required to be addressed instead. So whilst markets are quietly edging forward, we will look at this sector which had been out of favour for many. It was a very hard job through 2011 and 2012 to encourage investors to support this sector but, as can be seen from the chart below, the rewards are now evident.
Global real estate markets have enjoyed a strong run so far this year as the economic recovery slowly takes hold and broadens out. Demand from UK and overseas Investors for UK commercial property has been strong. The substantial weight of money in the market and the lack of available investment stock have meant that prices have continued to increase due to the competition for assets. Demand for assets in the property sector is from a wide investor base due to the higher returns than from other assets classes and as a result of investors looking to diversify their portfolios.
This is a trend that we expect to continue into 2015 and beyond. Return forecasts for the asset class are strong over a three-year holding period as underlying real estate fundamentals in most global markets continue to show signs of improvement. There are a number of key drivers behind real estate’s positive momentum. Greater confidence in the sustainability of the global economic recovery is seeing some businesses expand, take on more staff and consider space and relocation requirements that had perhaps been placed on ice in the aftermath of the global financial crisis. Another hangover from the crisis is the lack of supply of new assets, as developers postponed projects while the world tipped into recession. Now, demand for space is picking up and, amid dwindling supply, rental growth is materialising in many core markets. For the first time in a long time, the balance of power has swung in favour of landlords and fewer incentives are being offered to prospective tenants.
The margin that real estate offers over government and corporate bonds also continues to support the market. Although this has narrowed recently, the margin still remains healthy and is attracting investors in search of yield. In addition, high liquidity and improving credit availability is underpinning the real estate investment market, where volumes are strong.
Activity is across many sectors and geographies and the weight of money keen to access direct property continues apace.
In the UK, where we concentrate on investing, the yield gap between prime and secondary is still significantly higher than the long term average; however, this has narrowed over the last 18 months with both UK institutions and overseas investors increasingly looking to outside Central London for better value as confidence in the recovery grows. This has resulted in continued yield compression in the South East and Regional markets. Total returns are expected to be driven by both income and continued positive capital returns for the remainder of the year.
The Occupational market is continuing to show positive signs, with the gradual return to economic growth and renewed business confidence translating into increased leasing activity across many of the UK’s largest cities. Incentive packages to tenants are being reduced and in some sectors rental growth is being forecast, driven by reduced levels of accommodation combined with a dearth in construction activity since the beginning of the recession. Despite improved sentiment and deal volumes on the occupier side, there is still a lag in relation to the investment market.
Looking forward, property prospects look attractive based on the income return and expectation of further capital growth. The gap between prime pricing and secondary pricing is expected to continue to narrow during the course of the year as more investors seek value from the secondary area of the market. Total returns are likely to incorporate a positive capital return as well as the income return. Secondary stock is likely to continue to be favourable and it is expected that we will see more investors moving into the Regional markets and not just the South East.
There are a wide range of investors both UK institutions and overseas investors now actively acquiring in the market. Continued competition for assets is expected. Careful stock selection will remain a priority for both investors and tenants, however, we expect there to be a greater focus on investments with higher income returns and asset management opportunities as investors move up the risk curve to get value.
The availability of debt for commercial property is expected to continue to improve. Investors are likely to start to look for development opportunities including speculative development and lack of current development pipeline is expected to stimulate rental growth in certain markets. The City and West End of London will continue to attract interest from a wide variety of buyers, mostly overseas, although there is a widely held perception that this is fully priced and the funds that we support tend to be light in these areas and are unlikely to alter that stance.
So, all in all, we believe the outlook for real estate is promising, while the differing recovery profiles and growth rates between markets offer numerous investment opportunities.