CAPITAL WATCH: Investor pricing survey

This is the first Colliers International/Real Estate Capital UK Investor Pricing Survey to be conducted since March and the first post the vote for Brexit.

The results are clear: seven months on, sentiment is weaker, with the average total return from UK real estate for 2016 now expected to be 0.8 percent where six months ago it was 6.8 percent. The total return forecast for 2017 has fallen to 2.3 percent from 5.8 percent in March 2016.

Prime yields have moved up an average 40 basis points to 5.6 percent while secondary yields continued to rise, on average by 19bps to 7.4 percent. And there is almost no rental growth expected in the next two years.

The survey, carried out by Dr Karen Sieracki of KASPAR Associates and in its 23rd year, provides detailed analysis of industry expectations for property returns. There was no survey in July 2016 due to the timing of the UK EU Referendum.

Investment: Widespread selling

For the first time in several years, property was a sell across all main sectors and throughout the UK.

Wales and North East saw the highest number of sellers, 54 percent of the respondents for offices and 46 percent for both retail and industrial. In London, 40 percent wanted to sell central offices and a third of investors wanted to sell residential — which was also a sell in the East of England and the North East. Generally, the focus was away from Central London.

In terms of buying property, industrial assets remained the favourite with the sector a buy in the South East for 69 percent of the respondents, followed by West Midlands at 62 percent, then East of England and East Midlands both at 54 percent. Buying offices in the South East was mentioned by 46 percent of the respondents. There was little enthusiasm for retail.

Yields: Prime moves out

There was a significant rise in prime yields, by an average 40bps in the seven months to 5.6 percent from 5.2 percent in March, with shopping centres showing the biggest shift of 70bps and shops the least at 20bps.

For secondary yields the picture was more mixed. The average secondary yield moved out 19bps to 7.4 percent, but the range was from an 80bps increase to 8.8 percent for secondary business parks to a 50bps compression for secondary shops, to 6.7 percent (see charts). With yields on the best assets moving out faster on average than for secondary, the spread between prime and secondary actually narrowed, from 199bps in March to 178bps in November.

All prime sectors except for offices were either fair value or underpriced for 2016, 2017 and 2018. Prime offices were considered overpriced for 2017, then underpriced for 2018. Offices have passed their best in terms of performance but the market momentum is still evident.

“The big assumption”, Sieracki says, “is that there will be the largest capital loss in 2016, less in 2017 and then some recovery in 2018.”

Rental growth: Halting

The most dramatic change post-Brexit is in expectations for rental growth. Investors have slashed forecasts for 2016 by 50 percent since March, to 1.3 percent pa for the year (2.6 percent pa March 2016 survey), while the drop next year and the year after is even higher.

In 2017, respondents now expect rental growth to stay positive — just. They revised their forecasts down by 200 bps to 0.2 percent. All sectors were downgraded. Offices saw the most dramatic negative change of minus 510bps, followed by business parks of minus 270bps. The least negative change was retail warehouses at minus 90bps followed by distribution at minus 110bps. Respondents forecast that offices and business parks will see negative 2017 rental growth of minus 1.0 percent pa and minus 0.7 percent pa respectively.

In 2018, average rental growth is predicted to be 0.0 percent pa. Offices, business parks and shopping centres are negative. The worst rental growth for 2018 is business parks at minus 0.9 percent pa followed by offices at minus 0.5 percent pa.

Similar to next year, rental growth expectations for 2016 in all sectors were revised downwards. Offices saw the greatest negative adjustment of minus 290bps followed by business parks at minus 170bps; shopping centres had the lowest rental growth of 0.9 percent pa followed by retail warehouses at 1.0 percent pa. Distribution had the highest rental growth of 1.9 percent pa displacing offices.

Capital growth: Also crashing

Respondents also took a knife to annual capital ‘growth’ this year and next, with both years now expected to be negative. For 2016, respondents have revised their final year figures to a value fall of 3.4 percent, a turnaround from the positive growth anticipated of 1.5 percent last March and 2.9 percent a year ago.

In 2017, average capital growth was downgraded by 267bps to minus 1.9 percent pa from 0.8 percent pa in March 2016’s survey. The biggest negative adjustment was for business parks at minus 350bps followed by offices at minus 260bps. The least negative adjustment was minus 230bps for retail warehouses. The worst capital growth for 2017 was business parks at minus 4.0 percent pa followed by shopping centres at minus 2.4 percent. The best capital growth was for industrials at minus 0.9 percent.

Things start to improve in 2018 “with a subdued recovery” Sieracki says, and average capital growth going into positive territory of 0.4 percent pa. Investors believe only two sectors will continue to see negative capital growth: business parks at minus 1.3 percent pa and offices at minus 0.2 percent. The best capital growth for 2018 is distribution at 1.2 percent.

Brexit, she adds, “appears to have accelerated the capital decline over a shorter period.” The relative change from 2016 to 2017 for capital growth is now an improvement of 146bps (minus 71bps March 2016 survey, minus 237bps November 2015 survey). The relative change from 2017 to 2018 for capital growth continued this improvement trend of 231bps.

Total returns: Lowest since 2009

The upshot of the slashed rental and capital growth expectations is dramatically lower total returns for UK real estate in 2016, of 0.8 percent (6.8 percent predicted in March 2016, 7.8 percent a year ago) and for 2017, of 2.3 percent (5.8 percent in March).

2016’s forecast is the lowest forecast of total return since November 2009, though it was much lower then, at minus 6.3 percent pa. The respondents blamed a mix of rising yields and slowing rental growth; 23 percent thought that it was due to Brexit.

Total return for 2018 relatively improved to 4.7 percent pa. 31 percent of the respondents felt that the main driver for this improved return was a modest pickup in capital growth.

Yields: still low for longer?

Respondents were not unanimous in expecting the low property yields of the last few years to be sustainable. About two-thirds felt that they were here for a further two to three years, mainly due to low interest rates and also low gilt yields and weight of capital.

However, 38 percent did not think low yields were here to stay for various reasons: inflation and interest rates would rise and there would be political moves against loose monetary policy. There were worries about prospects for secondary and tertiary property. Other worries were that businesses and consumers were treating low interest rates as the norm. Some felt that low interest rates worsened bank profitability, the pension deficit and the social divide.

Some 62 percent of the respondents felt that the investor base for UK property would widen post referendum with more overseas investors due to sterling weakness.