Real estate sectors to leave and remain as Brexit uncertainty rocks Britain
Two years on from the vote for Brexit, the shape of the UK’s future relationship with the EU is still unclear. Nonetheless, the impact of the vote is already being felt in several sectors, with rising costs and continued uncertainty partially blamed for a succession of business collapses and investment cutbacks.
Despite these challenges, property investors should not avoid the UK altogether, in our opinion. By seeking exposure to structural trends, investors can tap into relatively Brexit-proof return profiles. Below are the two areas we believe investors should avoid as Brexit unfolds and several sectors that we think have a bright outlook.
Leave: UK shopping centers/retail
UK retailers remain under pressure, as demonstrated by a wave of store closures and bankruptcies (CVA’s) so far this year. Next to the obvious threat from online shopping, retailers are also facing more traditional headwinds, which mean that an increasing number of shops are trading unprofitably.
Costs continue to increase due to the weakening pound, which has been hit hard by Brexit uncertainty. Alongside relatively high rents and a continued increase in business rates, we see continued downside risks for retail properties—including the capital investment needed from landlords to keep their shopping centres competitive.
Economic conditions in the wake of the Brexit vote have also made it difficult for retailers to maintain revenue. UK GDP is slowing and, with saving rates at historic lows, consumers have limited room to manoeuvre with their expenditures. Meanwhile, average wages aren’t rising in any meaningful way, even as inflation sticks at over 2% and interest rates are near all-time lows.
Store closures are already impacting rents for traditional retail properties, a trend we do not anticipate reversing at any point soon. We believe a structural shift is coming, as both values and rents face downward pressure. We see a recent sign of this through AXA Investment’s withdrawal from a £700m deal to acquire a stake in the Bluewater shopping center.
While traditional retail is experiencing structural and Brexit-related headwinds, we believe e-commerce is the beneficiary of strong structural tailwinds. The UK’s e-commerce market was the third-largest globally in absolute terms in 2017, with annual sales of more than $81bn.
E-commerce is taking market share from traditional retail, with online sales growth continuing to outstrip physical store growth. We believe this secular trend will have momentum for several years to come and be somewhat immune from the impact of Brexit.
Property investors can benefit from this transition. Urban logistic facilities—used as the base for the final stage of delivery into urban spaces—are grossly under supplied, particularly in London where a significant degree of commercial land has been converted to residential use. Further up the chain, big box logistics facilities have a similarly compelling supply dynamic, as they take an extended period to fit out. As a result, existing facilities are seeing strong rental growth prospects and remain affordable. In our view rents could still double over the long term.
Leave: Central London offices
The London office market has been fueled by significant new supply entering the market over the last few years. However, we expect demand for these properties to slide as the Brexit process unfolds over the next 12–24 months.
We have already seen several companies announce staff moves away from London since the 2016 vote. Meanwhile, rents in prime areas such as Mayfair and the City of London remain at relatively high levels, which is encouraging new supply to come to market, further exacerbating the precarious supply/demand dynamic.
The market has held up better than we expected post-Brexit vote—but a large portion of the demand in the City has been driven by co-working office providers, particularly WeWork, rapidly taking up leases as the demand for shared offices has grown. WeWork takes long-term leases on large offices, in a similar vein to the traditional model for big businesses, before fitting these out and effectively subletting them to its members. As a result, it is locked into current market rents for the long term. Similar tenancy models have suffered when the market softened—and we believe this won’t be any different. As such, we believe it is warranted to remain extremely cautious on London offices.
One of the UK’s largest exports is its high-quality universities—which have been a beneficiary from the weak pound since the Brexit vote as they became cheaper for international students. We believe the best student housing platforms attract international students by offering attractive housing with additional amenities and services.
Self-storage is another lesser-known property sector with above-average risk/return metrics. It is supported by long-term trends, including smaller homes in urban areas, increased demand for flexibility and e-commerce, among others. We see healthy rental, occupancy and development growth trends over both the medium and long term.
Retirement housing and healthcare properties are another attractive property opportunity in our view—particularly GP surgeries. Crucially, there is limited tenancy risk coupled with sustainable yields because the assets are funded by the UK government and demand is secular. At the same time, the structure of the lease contracts provides inflation protection.
Rogier Quirijns, portfolio manager of the Cohen & Steers European Real Estate Securities Strategy