ANALYSIS: Over the past year, political uncertainty has influenced investment decision making like no other time in my career. The UK domestic economy, which was widely forecast to suffer significant headwinds, has stayed on the upside, owing mainly to the powerful buffering effect of a depreciating currency.
How many of us expected the UK to grow faster than any other G7 economy in 2016? So much for predictions that Brexit would trigger a near-term recession. Capital markets have remained relatively buoyant although with noticeably lower risk tolerance and a changing buyer composition. The period of “distress” in July of last year understandably produced exciting headlines, but the reality was different. Initial panic was short lived as an orderly resolution of both yields and occupier demand took hold.
So 2017 begins far healthier than we would have anticipated just six months ago. In large part this is because Brexit is proving more of a political construct rather than dictating business decisions at this stage. But what lies ahead? The rules of engagement between Britain and the EU are only beginning to be drawn and it is likely that at least two years of ambiguity will prevail before a clearer picture exists. So how will occupiers and global capital approach the UK during this period of uncertainty?
Recent transactional activity confirms that property investor appetite is returning after an understandable lull during the middle of last year. But the picture that is emerging is anything but uniform. Continuing a recent trend, UK institutions have been net sellers while private property companies continue to create liquidity for secondary assets. Big-ticket transactions have been dominated by overseas investors, led recently by Chinese and Hong Kong capital sources, highly discerning and focused on London. In the absence of truly distressed sellers, motivated one-off buyers are propping up historically high values.
The return of low-return investors to London is also an interesting evolution. Great Portland’s sale of Rathbone Place to Deka and the rumoured sale of Cannon Place to similar overseas capital sources show that certain core buyers believe in the long-term future of the UK’s capital city and the income security that London offices are perceived to offer. In terms of fundamentals, the London office market is holding up reasonably well. There was a noticeable increase in letting activity since the beginning of the year and there clearly remains demand for space in both central and fringe locations.
Despite this initial period of calm, it remains to be seen how deeply some areas of the UK and specifically London office market will be affected by Brexit-related dislocation and a foreseeable slowing of employment growth. While there has been limited reaction to date, occupiers most affected by the UK’s exit from the EU will not have the luxury of time to wait and see. At this point there is considerable political uncertainty across Europe affecting all of the next-best alternatives with elections in France, Germany and the Netherlands later this year. By the end of 2017 the outlook will be more certain, clearing the way for business decisions to be made long before the outcome of negotiations between the UK and the EU will be finalised. The potential for occupiers to relocate all or parts of their operation at a time when a potential supply overhang from 2018 could occur will amplify matters. The key question is whether other growth sectors will fill the void.
These threats are already being reflected in rents at the prime end of the market where headline rents are already under pressure. The impact of this sentiment adversely affecting the share price of REITs with significant London office exposure is a clear lead indicator that we can expect valuation volatility in the near term.
While the coming year could be volatile and one of price discovery for commercial property, we are encouraged by the fact that investors from around the world remain compelled to London. Brexit has not resulted in the city losing its standing as an attractive place to do business globally and that is reflected in the continuing appetite of global capital. The rationale for targeting this market reflect myriad push-and-pull factors which should endure as Britain redefines its relationship with the EU. As this proceeds we could begin to see interesting buying opportunities arise, particularly for overseas investors as they view the UK in the context of pricing around the globe and with the benefit of weaker sterling.
John Mulqueen is head of transactions, EMEA, CBRE GI
