Economic forecasters seem determined to talk up the UK’s prospects for the next two years, even though no one knows what the exit deal with the European Union will look like. How does this affect investment decisions that need to be made today? David Thame reports
Do you tend to see the clouds, or their silver linings? As Theresa May’s government prepares to trigger Article 50 of the Lisbon Treaty – the legal tripwire that removes the UK from the European Union by mid‑2019 – there are plenty of clouds and silver linings on offer.
Alas, neither the cloud nor the silver lining is much use to investors today. They need a good, compelling story – a narrative – that explains how to interpret the world in spring 2017.
One of the clearest stories is told by Prestbury’s AIM-listed Secure Income REIT. The company is not a typical investor: its £1.57bn portfolio depends on private hospitals, branded budget hotels and two well-known visitor attractions – Alton Towers and Thorpe Park. But its unusual portfolio – assembled with an emphasis on long-term income – provides a powerful and illuminating side-light on property’s Brexit upsides and downsides.
The story turns on one fact and one plausible assumption. The fact is that the UK economy did not crumble after the 23 June referendum vote, and is doing respectably well. The assumption is that now, and for much of the next two years, the eventual outcome of Brexit talks will be unknowable. There may be no deal, or a limited deal, or a brilliant deal. So in the meantime, what do you do?
Prestbury chief executive Mike Brown explains: “The fact that the economic shock we feared after 23 June hasn’t materialised has profound implications for real estate. We shouldn’t be surprised if property returns in 2017 are higher than many expect, assuming the economy continues to grow in line with recent quarters. From a commercial property perspective, the referendum result wasn’t the dramatic moment some predicted – but this may come later, depending on the nature of agreement reached on Brexit in 2019.”
Brown guesses this period (from now up to Brexit) will see slightly lower returns for property, but “it won’t be terrible”.
“While the economic forecasters have revised up their 2017 predictions for the UK, the real estate market hasn’t – yet,” he says. “There’s a consensus that property returns will remain relatively poor in 2017 and then there will be a recovery in 2018-19, but it’s hard to see why the market will be in recovery mode in 2018 with the Brexit outcome unknown.
“Yes, the property market is probably in correction mode – particularly for some retail and office sub-sectors – but real estate has to get used to the fact that Brexit is an unusual event operating over a relatively long time scale, with an unknown outcome. In the meantime, property will retain its appeal – it’s one of the few asset classes to provide a healthy income stream. The key is sustainability of income and long duration. Well-let assets will remain popular during this extended period of uncertainty.”
But the market will be uneven, Brown predicts. “We should expect some reduction in occupational demand from the financial services sector in the City, and it will be interesting to see if the current high level of demand for serviced office space and from the tech sector can be sustained. There’s also the question of an elevated supply of office space coming on stream in 2019-20. Weak sterling has prompted strong overseas investor interest in London, but this builds a certain fragility into pricing if a Brexit shock in 2019 were to materialise.”
He adds that elsewhere, a change in the value of sterling will lead to import inflation, squeezing real incomes and creating downward pressure on consumer spending. “Logistics and alternative property sectors are much more defensive as they side-step these issues and provide the income security that so many crave.”
So this is the story: offices slip down the investment agenda, and alternative investments/logistics rise up as investors seek longer-dated income, in the context of a generally prosperous UK. Until, that is, the details of the Brexit deal change things for the better (or for the worse).
It’s not hard to find people who agree that long-dated income is more appealing than ever. It is, after all, the classic strategy in times of stress.
Walter Boettcher, chief economist at Colliers International, says: “Most of the immediate Brexit risk has been priced into the property market, not least through devaluation of sterling. The danger is surprises in the negotiations.
“Long-income assets recovered quickly after last year’s blip – but look at the share price of London office provider Derwent. It has been trading down on its figures before the 23 June 2016 referendum, which is a contrast with the regional office REITs.”
But Miles Gibson, head of research at CBRE, has doubt in Brown’s narrative. “You can’t spend £53bn of annual commercial property investment on just alternative investments and logistics,” he says. “Yes, there was a fall in prices in 2016 and we expect commercial property prices to fall a little further in 2017 – perhaps 3-4%. That is not a major correction, and we see confidence recovering.”
Gibson sees the UK property market recovering at just the point that Brown sees it (potentially) heading in exactly the opposite direction.
Nick Montgomery, fund manager for Schroder Real Estate’s WELPUT fund, says that whatever the macro-economics, the property fundamentals will still matter. “Watch the take-up figures – supply is academic if there is no take up, and we have been pleasantly surprised by office take up since June 2016,” he says.
“Nobody knows where Brexit is going. I guess we’ll end up relying on some kind of transitional arrangement – but life goes on. Brexit or not, a windswept business park in the wrong location will always mean poor returns. A focus on flexibility is the wisest investment strategy.”
The sunny outlook
UK economic growth is stronger than expected, and stronger than many friends and rivals. The Bank of England has revised up its 2017 GDP forecast from 1.4% to 2%. Unemployment is 4.8%, the lowest for a decade.
The cloudy outlook
Announcements by USB and HSBC about moving jobs from London come at the same time as rising inflation, falling consumer spending and a weakening labour market. A think tank linked to the European Commission estimates 30,000 finance jobs will go thanks to Brexit as business worth £1.6tn moves to mainland Europe.
