It'll be UK in the end
2016 is likely to be a year of two halves for the UK investment market, according to Ben Clarke, Head of UK research at Cushman & Wakefield...
In 2015, did the UK experience another year of strong investment volumes? And what factors do you think contributed to this?
By many measures, 2015 certainly was a good year for real estate investment in the UK. The total amount invested in commercial property reached almost £62 billion in 2015, exceeding the £60 billion in 2014, and it was a second successive record year.
Offices are the most popular asset class among investors. Central London continued to prove extremely popular with investors, particularly those from overseas, given the large lots sizes, transparency and liquidity of the market, and its perceived ‘safe haven’ status in an increasingly volatile global economy.
Investment activity was aided by the greater depth and liquidity in the financing market, particularly in the UK regions where higher-yielding opportunities have presented themselves with improved underlying occupier markets underpinned by limited new developments. The office transaction volume in the UK regional markets reached £2.3 billion in 2015, the highest since 2006.
A broad range of bank and non-bank lenders are also targeting opportunities across prime and, increasingly, secondary markets. Consequently, many regional markets have seen an increase in institutional demand, while property companies and opportunity funds are also actively targeting stock with asset management and redevelopment potential.
Total return on commercial property for 2015 came in at 13.1 percent, a slowdown from the 17.8 percent achieved in 2014 but still the third consecutive year of double-digit returns. Direct real estate has now outperformed bonds and equities over a one-, three- and five-year timeframe.
The rate of yield compression across commercial property slowed over 2015, which contributed a progressively lower rate of capital growth. As Cushman & Wakefield predicted in 2012, higher-yielding secondary property outperformed prime property for a second consecutive year in 2015 with a total return of 18 percent on secondary, compared with 12.8 percent for prime. This was achieved as a result of the gap between prime and secondary yields narrowing further from what was an historical high during the financial crisis.
Did the Central London office market take advantage of the positive economic situation in 2015?
The central London occupational market remained strong in 2015, with an estimated 12.3 million square foot of space transacted. This was the third consecutive year of above average occupier leasing volumes.
Strong demand has chipped away at availability, which is now very low. Overall availability is 3.6 percent, but only 1.5 percent is top grade. Thus, the Central London market is currently controlled by supply-side conditions. Occupiers with large requirements are faced with dwindling availability of high quality offices. Development is increasing, however, spurred by easier access to finance. But the supply shortage is not expected to move into oversupply until later in the decade.
Rents continue to rise and increased by an average of 8 percent over the last 12 months. Strongest rental growth was seen in the emerging markets such as Aldgate & Whitechapel, Clerkenwell & Shoreditch and King’s Cross, which recorded growth in excess of 10 percent. The differential between the traditional core office markets and emergent ones is reducing.
The investment market remained strong, with the market’s safe haven status back to the fore amid renewed fears over global economic performance and stock market volatility, notably in China.
The sheer weight of money seeking an investment home, coupled with the large lots available, resulted in investment volumes standing at £22 billion in 2015, the third consecutive year of above £20 billion transactions and significantly above the long-term average of £16.1 billion.
As capital values increase, there is some profit taking evident in the market but, with liquidity evident from a wide range of investors and many investors seeking to reinvest to aid the diversification of their portfolio, it is unlikely to curb activity in the short term. More investors are looking towards new markets to find opportunities such as Clerkenwell and Shoreditch, Aldgate and Whitechapel, and Southbank, buoyed by strong rental performance and rising occupier appeal.
While the strong occupational market and weight of money continues to place yields under pressure, there was limited movement from their current historical low level. Prime city yields stayed at 4 percent while prime West End remained at 3.25 percent. Despite their low level, the property market still remains attractive compared to 10-year bond yields.
Were the Q4 2015 figures for real estate investment in the UK as expected? And did anything exceed expectation?
Typically the final quarter has a seasonal uptick in investment volume but this was not observed in Q4 2015 and it therefore came in under expectations. At £13.5 billion, this was significantly below the £19 billion that transacted in Q2. This was echoed in the largest submarket, Central London, where £5.4 billion was transacted in Q4, much lower than the £7.9 billion sold in Q2.
One contingent factor was that a number of transactions did not exchange before the Christmas period. However, both foreign and domestic buying was down in Q3 as well as Q4, arguing for a more sustained switch of interest, most likely to Continental Europe. In addition, ‘Brexit’ may have played a part in domestic investor decision-making.
However, Q4 2015 was an exceptional quarter for retail high street transactions, with 49 deals totalling £547 million, a 56 percent increase on Q4 2014. This ended a good year for retail in general (£12 billion in 2015 versus £10 billion in 2014). Retail investment activity has been growing in tandem with the recovery in the consumer economy in the UK.
Which areas of the UK saw the largest growth in 2015? And what are you predictions for the real estate market in 2016?
Investor sentiment early in 2016 is likely to be similar to the second half of 2015, with slightly lower activity reflective of institutions in particular, pausing for breath and taking stock of changes in the market. There will be limited pressure on landlords to sell and institutions are expected to take a back seat on the buy side despite having cash to spend. Consequently, we expect total UK investment in 2016 to come in somewhat below the record amount achieved in 2015.
That said, the UK economy is forecast to continue to easily outperform most of Europe in 2016 and, with a positive occupational market predicted, the property sector will continue to be a sought after home for international investment. Low bond yields as well as uncertainty and volatility in equity markets is only going to add to demand coming from both domestic and international players.
The international appeal of London will continue, with an ever-increasing spread of new global investors from all over the world entering the market. Foreign demand engaging with the London market will remain broad, with Asian investors anticipated to be a key source of demand over the next 12 months. The persistence of lower oil prices is now leading to some changes in investment policies, which is likely to curb the growth of Middle East investment demand over the next year.
So far Chinese investment has been increasing strongly in Europe as a whole, rising by 22 percent in 2015, reaching £2.2 billion in the UK in 2015. In the UK investment activity has broadened out from Central London to the regions and from offices to a broader range of asset types.
More broadly though, many UK property segments are now perceived as being fully priced and we expect the easing in yield impact over the course of 2015 to continue into 2016. We consequently expect total return to drop again in 2016, with most differences between the performance of alternative UK property segments to be driven by rental growth and income return.
Occupier markets are generally solid but those more cyclical markets are past the peak of the current cycle, meaning that industrial properties, with their steady rental growth and relatively higher income return, are forecast to perform relatively well over the coming years.
The biggest factor in 2016 is going to be the threat of Brexit. It may be that part of the slowdown in activity in the second half of 2015 was a result of the growing profile of the event, as anecdotal evidence suggests that the institutional investor slowdown in this period was caused by a ‘wait and see’ attitude.
The referendum on EU membership is likely to result in a pause in both occupational and investment activity across all UK segments during the negotiation phase until an element of certainty returns to the market. Exchange rate weakening is now significant, and there may be more in store. Foreign investors may be more sanguine than domestic but an adverse reaction to a decision to leave cannot be ruled out. Conversely, a vote to stay will quickly restore the status quo, and investment activity will recover accordingly. More than ever, 2016 is likely to be a year of two halves for the investment market.