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UK Commercial Property Set for Rebound

London, City of London, Central London offices, property, commercial property, retail, high street, real estate investment trusts

There’s a lot of cash on the sidelines waiting to snap up UK property assets once certainty on Brexit is known, according to real estate investment trust managers. However, they warn the market could see some short-term pain in the meantime.

Equity investors have been vocal in putting forward their expectation of cash flowing into the UK stock market once Brexit is resolved, no matter what deal we get. While it’s unlikely to be as dramatic in property, the asset class remains more resilient than many expected.

There’s money waiting to buy UK real estate, predicts Calum Bruce, manager of the Ediston Property Investment Company (EPIC), from both domestic and overseas buyers. “Once there’s some clarity, there will be a period where people will just digest what’s happen, formulate a strategy and then look to implement that strategy,” he tells Morningstar.co.uk.

Simon Marriott, investment director at London & Scottish Investments, agrees, though has sympathy with those continuing to hold off committing just yet. “I’m a believer when there is some certainty, anything other than no-deal, prices are going to get stronger,” he says.

Bruce explains that there is plenty to like about UK property, particularly for overseas investors looking for a safe haven in an uncertain world. “The UK ticks a lot of boxes for these investors,” he adds. These include a stable economy, favourable political climate for the asset class and yields higher than many other cities both in Europe and elsewhere.

“But why would they invest now if they think there’s going to be a slip in value and their euro or dollar will go further in a few months’ time? That’s why we need some clarity so these investors can go ‘right, now’s the time to come in and invest’.”

However, it seems likely it will be some time until that Brexit fog clears. While Prime Minister Theresa May’s extension to the Brexit deadline is flexible, odds are it will, again, go right down to the wire on October 31.

Therefore, this predicted pick-up in activity is likely to be a 2020 phenomena. Indeed, Nick Montgomery, manager of the Schroder Real Estate Investment Trust (SREI), thinks we’ll see a correction before any recovery comes about.

“Are we at the top of the cycle? If you look at the average for the market, we think values will fall,” he explains. “We’re not expecting a return to 2009 where values fell by multiples of 10%, but we are expecting a correction.”

As a result, he’s been selling some of his lower-yielding assets, including most of his retail portfolio, in order to build some cash and give him firepower once that correction comes.

Despite being late-cycle, Montgomery says there are plenty of opportunities around with “immense polarisation” between sectors. Below, we highlight three areas REIT managers are seeing, or expect to see, opportunities in the UK property market.

Regional Offices

Being the big hub, particularly for financial services firms, and capital, London will garner many headlines when it comes to the outlook for UK offices. However, many are now seeing opportunities some of the other larger cities in the UK.

Both businesses and the Government are beginning to spread their workforces around the country. The BBC has recently set up camp in Salford, while accountancy firm PwC has a new 80,000 square foot office in Leeds.

“These cities are not back-office locations anymore,” says Marriott. “These are all high-quality locations in their own right, with highly qualified workers who have made life changes [to] move out to the provinces because it’s closer to where they were brought up or their quality of life is better [than in London].”

With the UK one of the world leaders in artificial intelligence, companies are looking for more office space around university cities, too, like Oxford, Cambridge, Bristol and Durham.

Montgomery says Schroders is one of the biggest owners of commercial real estate in Manchester, having identified it as one of the “winning cities” in the UK moving forward.

“[Manchester has] great public sector leadership and a disproportionate share of public sector investment, which has drawn people into the city centre, with the population doubling over the course of the last 10 years or so,” he explains.

Retail Warehousing

Unsurprisingly, many are downbeat on the future for retail. Structural headwinds, including the increasing move to online shopping, have meant a lot of retail firms have either gone bust or are on shaky ground.

Those that have survived are now looking to downsize their store estate or reduce the rents they pay as shoppers increasingly eschew a trip to the high street or their local shopping centre.

However, there are still opportunities in retail. Bruce is the most bullish, arguing that the doom and gloom headlines don’t tell the whole story. “Retail is evolving; I don’t think it’s in terminal decline,” he says.

True, he cautions, retailers that have failed to adapt, evolve or change to the new environment will fall by the wayside, but others have done so and are well set to take advantage. Indeed, Bruce likes out-of-town retail parks in places like Hull, Barnsley or Sunderland, which lend themselves most to the click-and-collect model..

As ever, it’s all about good stock selection, of course: “not all retail warehousing is equal”. While the likes of Next and others are known to be looking at decreasing the rent they pay, they are also happy to increase their costs for units in good, profitable locations.

“We have a retail park in Prestatyn and have completed four rent reviews with River Island, Next, Card Factory and Costa and have got an increase on all of them because it’s a good park in a good location,” says Bruce.

The London & Scottish Investments team, which runs the Regional REIT (RGL), have only a small portion of their portfolio allocated to retail and that is overhang from portfolios they have bought.

Despite taking the decision not to consciously invest in retail when they launched their product back in 2013, they also have no plans to sell their two properties, which comprise a shopping centre in Bletchley and retail park in Swansea, any time soon.

“These are yielding well north of 8% so there’s no reason for us to sell them,” says managing director Derek McDonald. “We’ve got one very small void at Bletchley and none at Swansea and we’ve not had any CVAs, so why rush to sell them when they’re not hurting you?”

Central London Offices

Clearly, this one’s most at the mercy of the outcome of Brexit negotiations – and the UK leaving without a deal would not be positive for the asset.

But Bruce says the office market in the capital has been more resilient than expected. “There are people hedging their bets, but I don’t think it’s been as dramatic an exodus as people expected.”

True, the market has hitherto been too expensive for Bruce to justify getting stuck into, and pricing is still not there just yet. However, he’s encouraged that “more things are coming across our desk which we’re interested in doing something with”.

“Rents are probably under pressure more than they are in other parts of the country, but in the main there’s been pretty good take-up and supply is at a reasonable level.”