At a dinner this month I sat next to a fund manager whose expertise is UK property and he remarked that his next priority was to talk to his research colleagues about Japan. You may have already guessed what came next. He said he’d been thinking that it would be useful to find out what kind of property had performed best there during the country’s “lost decade” of the 1990s when an asset bubble burst and economic expansion came to a halt.
Exactly the same thing happened during a briefing with a different fund manager not long afterwards. “We think the UK is going into a Japanese-style lost decade situation,” he said, adding that his firm had also decided to study Japan to look at what happens when a country gets close to zero growth, zero interest rates and zero inflation. Pointing to record low bond yields – usually taken as a sign of anticipated lower inflation and slow growth – he said “we are of the same opinion”.
His firm’s view about what that means for the UK property market is broadly this: that the moment you step out of London and the south east, you should buy long leases with some form of indexation – but not linked to the RPI or even the CPI index. Better to try to agree an independent fixed figure, say 3%. Whether or not other investors come to the same rather gloomy conclusion about the prospects for western economies, sentiment undoubtedly became a lot worse over the summer break.
The first thing Real Estate Capital did this month was to canvass the views of European investors about the likely short and long-term effects of this shift on property markets (see Analysis, p11 and Viewpoint, back page). Opinion was polarised over whether property is indeed a hard asset and a safe haven; another view that is taking hold is that it is a dangerous time to invest in an asset class that is so tied to the wider economy.
If there is a consensus, it is that investing has got riskier, returns will fall but property will be supported by a lack of suitable alternatives for investment. Values may well be about to fall – imminently in the City of London, where 83 office buildings with a total value of £5bn are up for sale. However, for investments where the cash flow and income are relatively secure and sustainable, the asset class yield will still be attractive, compared with volatile equities and expensive government bonds.
And it is not a new point, but our commentators all said that the market is now even less likely to recover for poor quality “growth dependent” deals, with high leasing risk or where returns depend on poor covenants improving or just surviving. There will be no rising market to save these assets and without drastic write-downs, refinancing them will be well-nigh impossible.