UK commercial real estate prospects still positive

Giles Fuchs, CEO and co-founder of UK property investor Office Space in Town,  outlines his views on the sector’s outlook in 2016 and which areas are likely to offer the best opportunities.

Confluence of factors power commercial real estate to record years

Last year was a record year for investment in commercial real estate, with 2015 volumes reaching $700bn globally, over $300bn in Europe and £67.5bn invested in the UK alone. Across commercial property, sectors performed well and the appetite for office, retail and industrials was strong, with office continuing to lead the way.

The growing levels of investment over recent years have nearly taken commercial property investment levels back to the days of the pre-financial crisis peak. This strong recovery is due to a number of favorable factors, including unattractive equity and debt markets, persisting low interest rates and a lack of supply to meet investor demand. Investors still appear to be positive for the year ahead, for example, a recent CBRE survey of investors has revealed that 82% expect their investment activity in 2016 to be the same or greater than 2015.

Daunting economic and political headwinds cast shadow across the market
Investor confidence may appear misplaced, as a daunting set of economic and political headwinds, some short and some long term, are casting a shadow across the market’s potential and generating uncertainty amongst investors.

Indeed investment in the UK commercial property market is estimated to have fallen by £8 billion since the start of 2016. In the short term and the immediate concern for investors is “Brexit” and the impact that the UK’s potential departure from Europe might have on both their UK property interests and their interests in Europe. As the referendum approaches, more investors are adopting a wait-and-see attitude on any further activity and deals are beginning to stall.

In the longer term, there are a clutch of concerns. Last year’s rate rise by the Federal Reserve has stoked fears that global interest rates will rise, although the European Central Bank and the Bank of England have signaled that this is unlikely in Europe.

Also, given that capital values have increased 25% over the last three years, there is growing fear that the commercial property market has reached the peak of its cycle and that momentum will begin to slip. Further to this, experts predict that deal volumes, which have risen 20% per year in the last few years, will begin to stagnate. Another potential constraint upon investment in the commercial real estate market is the possibility that institutions will soon reach asset allocation restrictions to property in their portfolios and, as a result, will begin to limit their investment commitments.

Compounding this, there are growing fears that China’s economic slowdown will hit investments from Asia, which had been increasingly strong in recent years.  Furthermore, sovereign wealth funds, particularly in the Middle East where the impact of falling oil prices in 2015 was felt so strongly, have recently retreated and stalled on their buying.

The prospects for commercial real estate are still positive

Despite the limitations and concerns for investors, the 2016 outlook for commercial real estate remains positive.

Promisingly, the prospect of rising interest rates has started to recede and whilst the IMF has forecast subdued growth for 2016, there is no prospect of a recession, the herald for historical downturns in the commercial real estate market. Also encouraging is that there have been no indications that borrowing is getting out of control, with levels around £50 billion – still well below the £80-£90 billion excesses of 2006-2007.

The yield on commercial property remains far more favourable than that on bonds for investors; while the IDP All Property Index initial income yield is certainly lower than previous years (5%), it remains much higher than the 2% yield on 10-year gilts. A further reason for confidence for 2016, is the continuing low levels of development across the UK, which has seen the pressure on demand for property increase.

Indeed experts have confirmed that the demand across Europe is continuing to increase and across the whole of Europe, office take-up is set to grow a further 10% in 2016, with French and Spanish markets becoming increasingly attractive to investors and the major German cities beginning to challenge London in popularity.  Indeed second tier cities, such as Milan, Munich, are predicted to become an increasing focus for investors, as they shift away from capital cities. In some of the most popular capital cities, such as London, commercial property development is spreading further into the city fringes – testament to continuing high demand in the European markets.

In terms of sectors, hotels and student accommodation are already seen as defined asset classes. Over the past year, serviced offices have also emerged as an asset class in their own right. During the last decade, the serviced office sector has grown exponentially, with experts putting the growth of the sector at 20% per year over recent years.  Optimistic suggestions for the sector putting its value in the UK at £120 billion by 2025 and London is leading this growth, with 25% of the sector centred in the capital. With institutional investors looking for investments with a high yield and good returns, sectors such as serviced offices offer increasingly attractive opportunities.

Conclusions

The outlook for commercial property investment may at first glance appear gloomy, but we ought to be optimistic about the opportunities for potential in the sector. The development of new regional opportunities for investment and the emergence of new asset classes, indicate that the European commercial property market will remain firmly on investors’ maps.

 

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