UK property market - risk or opportunity?

Whenever the issue of investing in the UK is raised, there are always a few probing questions and eyebrows raised about recent Brexit-related political turbulence and the likely trajectory of the commercial real estate market.

Justified as these questions are – what investor wouldn’t be curious about the potential implications of the UK leaving the world’s largest trading block? All they are trying to do is understand whether or not the UK should be classified as a risk or an opportunity.

It is important to see through the headlines and focus on the fundamentals of the UK real estate market, which remain attractive, especially for overseas investors with long-term strategies.

The UK is consistently one of the largest real estate markets in Europe

Most investors with a track record of investing in Europe will, at one time or another, have held a proportion of their investment in UK real estate and will likely have been rewarded with healthy and sustainable returns, commensurate with their cost of capital and appetite for risk.

There are many reasons that explain why they choose the UK. Among them, the ability to access scale through multiple large cities, diversity of product, the depth of investors and the breadth and diversity of the occupier market. Importantly for institutional investors, the UK offers excellent liquidity, transparency and high-quality stock in large lot sizes.

These are qualities which are not always available to international investors in their domestic markets, where in many cases they are probably already heavily allocated to real estate and in need of diversifying their portfolios by geography and/or asset class.

International appetite for UK property remains strong

Evidence suggests interest in the UK remains robust. In 2018, overseas buyers accounted for a significant 50% share of activity across the UK market, a trend that continued into 2019 (45% of Q1 transactions). While London is a key target, maintaining its status as a global gateway city, several of the UK’s larger regional centres such as Manchester, Birmingham, Leeds, Edinburgh and Bristol have experienced rising interest from investors that is translating into deal such activity.

State of the UK market

While overall investment volumes in the UK were just shy of £11 billion in Q1 2019, down on the ten-year quarterly average, there are marked differences between sectors.

Hotels and the residential sector performed well in 2018, with annual trading volumes higher than those of 2017. However, traditional sectors such as office, industrial and retail reported declining volumes, albeit for different reasons.

The office and industrial sectors faltered largely due to the lack of product coming to market. Retail is slowing as further sectoral transformations continue. Digging deeper into retail, some subsectors, such as retail park continue to outperform while others such as small regional mid-tier shopping centres are showing signs of stress.

International appetite for UK real estate

Appetite for office assets remains strong, especially among Asian investors looking for large, single-asset deals with stable, long-term income streams in order to diversify from their domestic exposure. Added benefits of the UK include the level of market transparency and a sophisticated legal system.

In London, overseas buyers accounted for 70% of office deals in 2018, with Hong Kong, Singaporean and Korean investors the most active. However, good quality stock is hard to come by in a tightly-priced, low interest rate environment which is holding back higher levels of activity.

Sterling is still weak by historic standards and for those that can see through the noise to take a longer-term view of the UK, there are opportunities to be had in both London and the regional cities, where supply constraints and a lack of speculative development remain key drivers of performance.

The UK is also an important and growing market for flexible workspace solutions, with the concept being increasingly adopted by new entrants to the market. Currently, an estimated 5.1% of Central London’s office stock is occupied by flexible workspace operators, up from just 0.8% in 2008.

Industrial and logistics continue to benefit from e-commerce

The UK has the highest level of online shopping in Europe, with e-commerce accounting for 17.6% of total sales as of February 2019. Comparatively, in the United States, this figure sits at just under 10%, while it is around 8% in Australia.

As a result, demand and pricing of warehouses and delivery hubs in the UK is expected to remain solid, sustained by the consumer habits in particular of millennials and generation X. However, competition for city fringe land used for urban logistics will increasingly compete with alternative sectors such as residential.

Retail requires an innovative approach

The continued rise of e-commerce is a double-edged sword. There is a widely held conviction that the rise of online shopping will be to the detriment of ‘high street’ retail, which is already suffering.

The challenges faced by the retail sector have been widely documented, caused largely by the aforementioned fundamental shift in consumer behaviour. The investment opportunity lies in partnering with those who succeed in putting the consumer at the heart of their retail real estate transformation, intelligently embracing technology and creating responsive and innovative experiences.

Healthcare and hotel sectors also set to benefit

Healthcare and retirement living is a target for investors who have recognised the long-term implications of the UK’s ageing population on the demand for healthcare assets. The hotel sector is also benefitting from the effects of a weaker currency and strong tourist numbers.

What about Brexit and future opportunities?

Whatever Brexit brings, the UK still has a lot to offer from a commercial real estate perspective. As ever, it’s all about choosing a suitable entry point and selecting the right assets and locations to suit your risk profile, which isn’t possible without a bottom-up approach and trusted feet on the ground.

Since the referendum vote, growth in the UK economy has slowed, providing a degree of dislocation between the UK and some other European economies. The forecast for 2019 is marginally above 2018 at 1.5% GDP growth, and is expected to rise to 1.7% in 2020, supported by strong employment and real wage growth.

With this in mind, long-term income strategies will likely be attractive against a backdrop of bond yields, which are set to rise from historic lows, as well as rising property yields, caused by weakening pricing in some locations and slowing, albeit largely positive rental growth, particularly in supply constrained areas.

Prime assets will remain popular with international capital, as they provide stable returns and a buffer to any short-term volatility. In the secondary markets, where conditions are more challenging, there are still opportunities to purchase value-add assets at a reasonable discount.

Despite uncertainty around the outcome of the UK’s potential exit from Europe, the long-term fundamentals of the UK commercial real estate market remain solid. There are opportunities for long-term investment strategies as well as short-term, higher-yielding strategies, providing investors select the right assets at the right price at the right time.