Given that the UK property market looks “fully priced”, that a “pricing correction” of some order could be in the making, and that Brexit is weighing on sentiment, investors can be forgiven for nervousness about the lack of economic and political certainty, writes Walter Boettcher, director of research and forecasting at Colliers International.
Analysis of this uncertainty would include a ponderous and unwelcome visitation of the many Brexit themes – the future relationship, the trade in physical goods, supply chain impacts, cross-border provisioning of financial and professional services, freedom of capital and labour movement, corporate tax disharmonisation, the fragmentation of regulatory regimes, political and geopolitical instability, to mention just a few. The result, though, would remain inconclusive.
Keeping the powder dry
The theoretical Brexit discontinuity has already put off many practical investors. Why invest when a major change in a political environment is imminent, especially when there is already nervousness about late-cycle risks. Back at MIPIM 2015, a Twitter survey was conducted among seasoned property veterans, who concluded that 2018 would be the year that the cycle would end. Cycles, of course, have no end – as 12 respondents correctly noted – but the question that was most likely “understood” by respondents was: when will the market peak and rental and capital values begin to fall?
Given that sentiment is already affected by the perceptions detailed above, and given that “chartists” who analyse the shape of data curves are nervously taking stock, then if investment is likely to take place in 2019 (and especially before Brexit day, 29 March) it must obviously be explained, at the worst, with words such as “fool” and “money”. But perhaps a somewhat more charitable description would be to invoke what John Maynard Keynes referred to as “animal spirits”.
“Animal spirits”, as it is used in a modern economic context, arises in Keynes’s famous 1936 work The General Theory of Employment, Interest and Money. As he put it in section 7 of Chapter 12, entitled The State of Long-Term Expectation:
“…a large proportion of our… activities depend on spontaneous optimism rather than on a mathematical expectation… a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities”.
Investment has indeed lagged behind last year’s corresponding year-to-date volume, but with transactions topping £5bn in the first two months there must be quite a lot of “spontaneous optimism”. Furthermore, around 30% of this investment originated with “disciplined” UK institutional and listed property companies. Investment driven by pure animal spirits seems alien to investors with fiduciary responsibility – certainly to pension fund operators awash with new cash inflows from automatic enrolment. Clearly, there must be another narrative altogether that has less to do with animal spirits and more to do with property market fundamentals.
In fact, if market fundamentals are revisited, both positive and negative signals are evident, but on balance – and given the investment already witnessed in 2019 – the signals must still add up. If the financial environment, crucial to investment, is considered, it is almost enough to say that 2018 in no way reflects 2007, when the UK property cycle took a decisive, epoch-making turn.
At the end of 2018, the base rate was 0.75%; in mid-2007 it was 5.5%. The gilt rate was 1.31% at the end of 2018, compared with 5.43% in mid-2007. Today, property equivalent yields are 450 basis points higher than the 10-year gilt benchmark. In 2007, there was a yield gap inversion – the cost of debt was higher than the yield on the property that was purchased with the debt. Bank lending to real estate is now one-sixth of what it was in mid-2007.
Hence, the seasoned MIPIM 2015 survey respondents (above) may have been wrong-footed by financial events – or, more precisely, by the lack of events. The fallout from the Great Recession is still very apparent in the market, judging by the rates.
Strong and stable
The market has an even greater underlying stability that is linked to the same force that may explain UK economic resilience after the 2016 EU referendum.
Long-term positive demographic growth, especially working-age population growth in the UK, is supporting the real economy. Likewise, global population growth and ageing is driving an unprecedented accumulation of capital and a growing demand for retirement annuities.
The global search for yield is intensifying and, according to recent projections, the increase in fund allocations to relatively secure high-yielding property may rise by an additional $2.5tn by 2020 – an amount equal to almost twice the total of annual global investment in commercial real estate.
It is risky to tempt fate by arguing that it really is different this time, but one thing is for sure – the numbers certainly are!
