The cocktail of uncertainty and, in particular, the heightening eurozone sovereign debt and banking crisis, are further fuelling the view among global investors that UK real estate represents a useful “safe haven”.
This perception has been supported in recent years by anecdotal evidence. As an example, the City of London property market has never before been so dominated by overseas capital. Only last month it was reported that 52% of the City by floorspace is now held by foreign investors, up from only 8% in 1980. But to universally assume that UK real estate is a safe haven would be foolish.
An assessment of UK real estate as a safe haven investment requires careful qualification.
To start with, we need to define what is meant by safe haven, and it is worth looking across other investment assets to do so. In theory, a safe haven would need to have a low correlation with stocks and bonds in a market crash, in a downturn it should be counter-cyclical, and it would need to exhibit low volatility. Ultimately, a safe haven needs to be trusted by investors to retain its value when times are tough, more than other investments.
UK’s reputation is intact…
To find a point of comparison in the sphere of commodities, the nearest to a safe haven is gold, which has long been perceived among investors as able to provide protection against both inflationary and deflationary environments, notwithstanding its volatility. It is characterised by a finite supply, and is easily tradable and well understood.
In the world of property, the search for a safe haven must start with macro considerations. For the destination of the investment, is there a credible government with a stable currency? Is there a strong legal system that adequately protects ownership?
In these respects, the UK is relatively well positioned. It offers one of the most reliable and predictable legal systems in the world, and the UK government’s early and public austerity measures have meant that the UK’s reputation, in terms of sovereign debt, remains largely intact.
Looking deeper into the characteristics of property, the UK’s perceived status as a safe haven is further derived from its tendency towards long (albeit shortening) lease structures versus other countries, and upward-only rent reviews to provide growing incomes. It provides a relatively high level of liquidity and transparency, based on well-regarded market practice and a professional valuation industry.
Importantly, the lease structure may provide an inflation hedge, particularly if the lease includes a specific inflation-linked clause, which provides protection in a stagflation scenario.
Additionally, and perversely a self-reinforcing feature, commercial property in the UK is seen as a safe haven due to the sector’s global appeal, attracting a diverse spread of international equity and occupiers.
…but its economy is fragile
On the other hand, the UK is not without its problems. There is no doubt that tenant default rates will rise against the background of tepid economic growth. There remains significant concern over frailty in the financial services sector and the UK banking sector, as well as concerns for consumer-related businesses and the wider economy.
Furthermore, much of the UK property market does not fit into the safe haven definition. Inflows of foreign equity continue to be stubbornly focused on very specific prime parts of the UK commercial real estate market, most particularly within London. But within the central London office market, the perceived disparity between secondary and prime remains prevalent, and therefore asset selection is paramount.
More widely, as a location, London has always benefited from some strong covenants, housing the UK headquarters or European bases of many financially dynamic, international companies. At the same time, there are properties with fragile tenants and short leases, which leave investors dependent on economic growth, which is weak.
Meanwhile, assets with planning permission, and incomplete developments that will produce the prime buildings of tomorrow, are not liquid or transparent.
Together, these characteristics are creating wide divergences in the popularity of different sectors of the market, with strong signs emerging of supply shortages for property assets that tick all the boxes for safe haven investors. Ultimately, this will result in pricing bubbles where appeal is most popular, and underpriced corners of the market, where fundamental worth is better hidden.
The overall UK property market will therefore not be a safe haven and nor will it be fool’s gold. It will remain like the curate’s egg – good in parts.
In such uncertain times, there is no asset class or market that can be seen as a guaranteed safe haven. An intelligent interpretation of the true risk and returns available from different elements within the UK property market will see through broad-brush generalisations, and in today’s market, will provide a source of significant relative outperformance.
