The case for the UK property market
The UK property market had a difficult year in 2019 but we need to separate the signals from the noise.
First some numbers. IPD monthly total returns for 2019 were 2.1%, down from 7.5% in 2018 – pending release of the IPD annual index on 2nd March. However, the listed real estate market tracked up to 30.6% - everyone would have been happy with that.
The FTSE 100 was more inclined towards the UK market and business did well at 19.2%.
Looking at income return, real estate is still doing that one thing that everyone wants it to and where else do you get income?
Breaking down UK real estate investment by sector a lot of the market's performance was stripped out by the one sector that people weren’t investing in: retail.
Will this year be the year we see a correction in retail?
In the listed sector, everybody was trading at or close to a discount but the market performance suggests that the discounting has perhaps been overdone.
Who drove the performance? Here are just two examples: 60% returns for Grainger residential and 60%+ returns for the Self Storage.
In London, Portman Estates, Workman and Derwent London have been coming back to virtually zero discount, constituting a real correction in the market.
What last year’s data also shows is the dominance of specialists, the alternative sectors and the operator.
Investment decisions are driven by industry sentiment but also by market liquidity which has dropped since June 2016 across the key UK cities including London – Edinburgh being the notable exception.
Europe didn’t have the same problem and as a result, Paris took London’s crown in terms of investment volumes.
Overseas investors still dominate the UK investment market with most of that money going into alternatives leading to a shift in the stats. Beds and booze – alternatives and leisure - now account for about a third of the market which is equivalent to the office sector.
Looking forward, do we see an uptick in investor sentiment translating into improved deal volumes? Hodes Weill/Cornell University’s annual survey of global investors indicated that 97% of respondents are actively investing in real estate with 50% saying they are underweight.
The yield gap with triple B rated corporate bonds has never been bigger which still gives you your case for investing in real estate.
However, there is a key challenge ahead: Climate change. The built environment is the largest contributor to carbon emissions of any sector and the environment tops business concerns.
Our occupiers are saying they want carbon neutral real estate.
There is a view that by 2030 we will have just the A and B EPC ratings on buildings and everything else becomes unlettable. We are sitting on a real estate depreciation time-bomb because the cost of making buildings carbon neutral is, on the whole, not being factored into the market and valuations.
But putting that all to one side and finish with our forecast, if you forget retail, we predict ungeared total returns this year of between 5% and 5.5% ungeared. In simple terms, it means that the market is still in the sweet spot most long term investors are saying they want to be.