With Brexit resolved, a Covid exit strategy in place, the economy rallying and attractive yields on offer, it looks as though everything is falling into place for UK real estate. But beneath this rosy picture, not all areas and segments will fare equally well. So what does it take to navigate this promising yet complex market with confidence?
The avoidance of a no-deal Brexit removed a major downside risk. UK business confidence is at a 14-year high, and companies are likely to resume investment after adopting a ‘wait and see’ approach in recent years. A deal to cover financial services has proved elusive, but the UK has been diversifying away from finance since 2012 in favour of technology and professional services. Consequently, the risk to overall employment is lessening.
In addition, a clear pandemic exit strategy on the back of the advanced vaccination programme should facilitate a permanent exit from lockdowns and unleash significant pent-up consumer demand.
Aside from economic fundamentals, the rationale to invest in UK real estate is clear. First, the asset class offers an extremely wide yield spread over gilts. Second, UK property appears under-priced compared with European markets. Brexit uncertainty meant the UK did not experience the yield compression seen on the Continent pre-pandemic, and for international investors the reduction in hedging costs over the past 12 months also makes pricing more attractive on a relative basis.
Prime London City office yields in the final quarter of 2020 remained at Q4 2016 levels and were higher than in other major European cities. By contrast, prime yields in markets such as Paris, Berlin, Munich and Madrid have fallen below their Q4 2016 levels, in some cases by as much as 80 basis points. Alongside positive economic momentum in the UK, this pricing disparity, lower hedging costs and decrease in Brexit uncertainty should support yield tightening.
That said, the recovery may not be universal. The pandemic has hastened structural changes that have been unfolding for several years; as a result, the market is polarising rapidly. This is evident both between sectors and within sectors, as different winning and losing locations and assets emerge from shifting occupational demand. Even the logistics sector, which has delivered strong returns this year, is experiencing a widening quality-linked gap in performance as occupiers become more discerning.
In this context, pursuing a forward-looking, thematically based investment strategy is more important than ever. This strategy should address three key considerations:
First, it must identify sectors and locations that will benefit from the structural changes in the economy and those that will drive consumer and business demand.
Second, properties must meet the demands of end users. It is no longer enough to own an asset in the ‘right’ location; the asset itself must be aligned with thematic changes or have the scope to be adapted to meet these changing demands. For example, in the office sector, consideration should be given to key factors such as natural light, air quality, adaptability, smart building technology and local amenities.
Finally, as demand for a more flexible, service-led offer emerges across the real estate spectrum, investors must step up their operational involvement. Investors with greater operational control of their assets can deliver a tailored product that is better aligned with the needs of end users. They will have more success in attracting occupiers, thus capturing rental premiums and reducing voids.
Our investment in Forge, Woking, a centrally located office building (pictured), and its refurbishment was informed at all stages by our thematic strategy. Our analysis indicated that the town’s characteristics suggested it would be resilient to structural change, and even benefit from it in some respects. During the refurbishment, the demands of the potential end user were carefully considered, feeding into the specifications. Particular attention was given to the arrival experience, end-of-trip facilities, adaptability, flexibility and the layout's ability to support the development of a community within the property.
Conditions in the UK real estate market indicate clear opportunities for growth. However, in a polarising market, the risks are numerous. To exploit this window, a thematically driven investment strategy coupled with discernment will be critical.
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