As 2015 ended there was a lot of discussion about the direction for property in 2016, particularly in the UK where the question was whether the market has peaked.
On the one hand, the high returns of the last couple of years are not ‘normal’ and the more bearish investors are selling anything they wouldn’t be happy to hold through a downturn. The Bank of England and the UK government ended the year nervous about the residential market and piled on new taxes to buy-to-let investors.
The bulls will counter there’s still a significant yield gap and future UK interest rate rises look both small and some way off. Yields may flatten but they may not move out – yet.
Global capital continues to look for a home and likes real assets; geo-political instability doesn’t harm the safe haven status of Europe’s strongest cities, especially London. Well positioned development schemes continue to catch market demand in the right sectors and in locations with the prospect of rental growth. Vacancy rates in major office markets are low.
On balance, the views from six commentators below are that we can expect a slowdown in certain markets, and some weakening in investor confidence. But with improving outlooks for economic growth and productivity in many European markets, and commercial development at a low point, the prospects for rental growth are good and will underpin returns.
Global transaction volumes are at record levels and performance has been strong, but there have been recent signs of appetite abating and many assets are fully priced believes head of Hermes Real Estate, Chris Taylor.
“Real estate is likely to remain an asset class of choice delivering income, a positive spread over bonds and real asset exposure in a world of uncertainty. That uncertainty includes a shaky recovery, unstable growth, persistent low interest rates, quantitative easing and increasingly weak inflation.
“Yield compression has driven global real estate pricing back to pre- crisis levels, not always supported by the fundamentals, and many markets today are looking fully priced… value for investors will be difficult to find in 2016. Our focus will remain on developed markets where powerful structural change factors (demography, technology, urbanisation and sustainability) provide momentum regardless of cyclicality, for example: regeneration supported by new infrastructure; alternative sectors including heathcare, student housing, and debt; and new specifications for traditional spaces, including offices and retail, to meet evolving requirements.”
A weakening in investor confidence is likely to have more effect on European property markets than the impact of the 16 December 2015 US rate rise, according to Chris Nicolle, senior adviser with law firm Norton Rose Fulbright:
“So, after nine and a half years, the Federal Reserve has once again raised interest rates, accompanying the 25 bps increase with plenty of market calming noises as to the likely pace of further rises in 2016.
“How will this impact UK commercial property? Probably in itself, not much. 2016 pricing will be affected much more by “investor confidence” (much weaker than 12 months ago) and existing pricing levels (high). So investors can expect lower, single digit returns in 2016, with greater emphasis on income and rental growth prospects. This is already manifesting itself with a rush of “late sellers” and shorter buy side auction lists. Next stop will be yield decompression, though at this point this looks neither close nor significant.”
Andrew Angeli, senior associate with CBRE Global Investors, suggested that a market correction is inevitable.
“Although we are positive about near-term prospects, it is vitally important to recognise the cyclicality of the UK property market and the inevitable market correction at some point in the future.
“Rising interest rates, uncertainty around the prospect of Britain leaving the EU, a global bond market dislocation or, more ominously, a black swan event are all possible triggers that could start the ball rolling.
“Now is the opportune moment to take advantage of the positive market sentiment to de-risk traditional property portfolios. This includes selling under-performing assets and reducing debt positions, but in conjunction with securing income from high lease value properties.”
Schroders’ Duncan Owen explains that, after a strong 2015, we can expect performance across different parts of the real estate sector to be more polarised over the next 12 months:
“2015 has been another good year for UK commercial real estate and unleveraged total returns are likely to be close to 15%.
“Whilst one of the drivers for another strong year has been a continued favourable fall in real estate yields, the key difference to 2014 is that this year has also seen a broad-based recovery in rental values. While Central London offices have led the upswing, several other cities have also seen a significant increase in office rents. Likewise, industrial rents rose in many locations. In contrast however, the retail sector is still adjusting to a world of multi-channel sales.”
Owen says that the 25 percent rise in capital values in the last three years does now mean we are at the top of the cycle.
“On balance…we think that capital values are likely to rise in 2016, but at a slower pace than in 2014-2015. We anticipate that total returns will still be respectable at between 7-9%. There are, of course, risks around this outlook. One possibility is that 10-year gilt yields jump more sharply in 2016 than anticipated. A second risk is the EU referendum. If the UK were to leave, then UK real estate could be hit as various investment banks and institutions, as well as some manufacturers, switch to continental European locations.”
Morgan Stanley’s European real estate equities research team remain positive on London offices and see good returns elsewhere in Europe.
“We are not changing our assumptions for London offices (high single digit rental growth and flat yields in 2016), but we think there are now more downside risks to our numbers than scope for meaningfully positive surprises in London investment markets compared to a year ago. But this is partly priced in as stocks have de-rated.
“Buying Spain is now more consensual than it was a year ago but remains a source of outsized returns for equity investors for years to come we believe. German residential capital value growth could surprise positively we think driven by an increasingly widespread housing shortage.”
Pramerica Real Estate Investors’ managing director and global head of investment research, Peter Hayes, cited several major themes for 2016, globally.
“We expect global transaction volume to increase further in 2016, as investors have plenty of capital to deploy and occupier fundamentals are improving. Portfolio deals and cross-border capital flows are gaining market share, a sure sign that investors are searching more widely for returns and looking to deploy capital quickly.
“Real estate yields are at record lows in many markets, but we expect further yield compression in 2016 due to relative pricing and market momentum. Recent years have called the benefits of market-level diversification into question, but correlations have dropped, making active allocation strategies more attractive.
“Investors typically respond to expected occupier market performance. We anticipate a rotation of capital away from gateway markets as growth broadens. Even if demand growth is modest, a low supply pipeline points to falling vacancy, which normally goes hand in hand with rental growth.”