Investors are taking a cautious approach to the UK commercial real estate market, the results of the latest Colliers International and Real Estate Capital Investor Pricing Survey show.
Total return expectations for 2017 fell since the last survey was conducted in November 2016, with expectations for 2018 also revised downwards.
The survey, carried out by Dr Karen Sieracki of KASPAR Associates is now in its 23rd year. It analyses the pricing of the different property sectors for both prime and secondary product.
Investment: Industrial popular
Real estate investors selectively bought and sold property across regions and sectors. Industrial was seen as a particular purchase opportunity by 55 percent of respondents.
South-East industrial was a top pick for 88 percent of respondents, up from 69 percent in the November 2016 survey, followed by central London and the east and west Midlands, which were each identified by 55 percent. On the selling side, 55 percent of respondents were aiming to divest central London offices.
Yields: Further compression
Prime yields compressed on average by 21 basis points from 5.6 percent in the November 2016 survey to 5.4 percent, following an increase of 40 bps recorded last November. Prior to that, yields had been on a downward trajectory.
Secondary yields also came in, on average by 19 bps to 7.2 percent, regaining ground lost last year.
Prime retail yields remained the lowest at 4.4 percent and continued to be the only sector to have a sub-5 percent yield. Prime business park yields remained the highest at 6.4 percent. The greatest compression was 50 bps for prime shopping centre yields which came to 5.2 percent. Prime retail warehouses were the only sector to see outward movement at plus 20 bps to 5.8 percent. The highest secondary yields continued to be business parks at 8.3 percent, while the lowest secondary yields continued to be retail units at 6.8 percent.
The overall gap between prime and secondary yields increased minimally by 3 bps, reversing the reduction of 21 bps seen in the November 2016 survey. The overall gap was 181 bps. Overall, prime offices, business parks and shopping centres are seen as overpriced in 2017 with retail units seen as fair value. All sectors are expected to become under-priced in 2018 as rental and capital growth improves. Secondary sectors continue to be seen as under-priced as yields remain relatively high and total return expectations have reduced.
Rental Growth: Expectations downgraded
Expectations for average rental growth for 2017 were revised downwards by
30 bps, going negative to minus 0.1 percent per year, from 0.2 percent per year in the November 2016 survey. Only two sectors were upgraded; industrial by 160 bps and distribution by 110 bps. The remaining sectors were downgraded, with shopping centres seeing the greatest change of minus 110 bps, followed by business parks at minus 100 bps.
The highest rental growth expectation for 2017 was industrial at 2.4 percent, followed by distribution at 1.8 percent.
Average 2018 rental growth expectations were revised upwards by 41 bps to 0.4 percent per year, from zero growth as seen in the November survey. Industrial saw the best improvement of 140 bps followed by business parks at 120 bps.
While offices and business parks had the worst rental growth expectations for 2017, an improvement is expected in 2018.
Capital Growth: Expectations remain negative
Average capital growth expectations for 2017 were minus 1.5 percent, upgraded by 40 basis points from minus 1.9 percent in the last survey.
The most notable positive adjustment was distribution by 310 bps, followed by industrial by 240 bps. These two sectors had the only positive capital growth forecasts for 2017, at 1.9 percent per year for distribution and 1.5 percent per year for industrial.
Offices and shopping centres had the worst negative adjustment of minus 180 bps and minus 120 bps respectively. There was no change for business parks and retail warehouses from the November 2016 survey. Business parks had the worst capital growth expectations for 2017, a forecast of minus 4 percent per year, followed by shopping centres of minus 3.6 percent per year.
Average capital growth expectations for 2018 dipped into negative territory at minus 50 bps to minus 0.1 percent. The greatest change was seen in shopping centres at minus 100 bps followed by retail warehouses at minus 80 bps. Industrial was the only sector which saw a positive adjustment of plus 20 bps. Only three sectors were forecast to see positive capital growth in 2018; industrial at 1.2 percent per year, distribution at 1.1 percent per year and retail units at 0.1 percent per year.
The relative change from 2017 to 2018 for capital growth expectations was 143 bps, where in 2018 there would either be less capital loss or actual capital growth. The best adjustment recorded was for shopping centres, at plus 320 bps, while the distribution and industrial sectors were forecast to see their positive capital growth fade in 2018, with negative adjustments of minus 80 bps and minus 30 bps respectively.
Total Returns: Expected to fall
Forecasts for the total return for 2017 fell by 20 bps to 2.1 percent from 2.3 percent as seen in the November 2016 survey. “Brexit-fatigue could have set in with investors just watching and waiting to see what happens,” said Sieracki.
UK economic figures have remained positive, but the value of UK non-food retail sales fell on an annual basis in the three months to the end of February for the first time since 2011. There were various reasons given for 2017 performance expectations; 27 percent of respondents felt it was due to Brexit, 27 percent felt it was due to geopolitical risks. On a more positive note, 36 percent of the respondents felt that sterling devaluation was an incentive.
Total return expectations for 2018 also fell by 80 bps to 3.9 percent per year, from 4.7 percent per year seen in the November 2016 survey. Again, 27 percent of respondents felt the main driver was Brexit and another 36 percent felt it was the income element that would help to drive returns.
Trump and hard Brexit
A total of 73 percent of respondents felt that Donald Trump’s foreign policies posed a low risk to the UK market, with the country seen as a safe haven. Some even felt that Trump’s reflationary position was good for real estate and that his position on US trade relations was unlikely to have an impact in the UK.
Meanwhile, 73 percent said that a hard Brexit from the EU presented a high risk due to its impact on consumer sentiment and medium-term economic growth, together with the likely increase in finance rates. As to whether the serving of Article 50 would cause a knee-jerk reaction in the UK property market, 82 percent said no, as the property market had already priced this in.
The rise of eurozone populism and indeed the potential collapse of the eurozone was seen as a medium risk by 64% of the respondents.