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As we count down the clock to 29 March, the date the UK officially leaves the European Union, Brexit uncertainty continues to cloud the outlook for UK investment assets. This is particularly so in the property market.
Ever since the Brexit vote 30 months ago we have heard warnings companies - particularly those in the financial sector - would abandon their London headquarters in favour of an EU-based city such as Frankfurt or Paris.
But it’s not only the commercial property market that is suffering, the capital’s residential market has slumped, too. According to investment bank UBS, 39% of all residential properties on the market have been reduced in price, nearly double the number from early-2016, before the vote to leave the EU.
The level of discount, is also increasing and the average days a property spends on the market is at a high of 128, up from an average of 77 days pre-referendum.
Meanwhile, research by estate agent Hamptons International shows overseas landlords are shunning the UK rental market. The share of new lettings accounted for by landlords based outside the UK has more than halved in eight years, falling from 14.4% in 2010 to 5.8% in the first 11 months of 2018.
In London, the number of houses rented by an overseas landlord has fallen from 26% in 2010 to 10.5% as at 30 November 2018.
Aneisha Beveridge, head of research at Hamptons International, said: “International investors are quite savvy about what’s going on in the UK housing market and their future expectations of price growth are weaker than they have been for some time.”
Brexit Uncertainty Remains
The immediate aftermath of the referendum, a number of open-end UK property funds closed temporarily, as investors rushed to exit and asset managers were unable to fulfil redemptions. In the months following, many of the funds in question sold buildings in order to build up a cash buffer against any future shocks.
“Whether we have a soft Brexit, hard Brexit or no deal Brexit will play a big role in returns for 2019,” says Chris Godding, chief investment officer at Tilney. Godding expects a mid-single digit return from UK property in 2019.
In fact, despite the uncertainty, property funds did relatively well in 2018. The Investment Association UK Direct Property sector was the best performing over the 12 months, with the average fund returning 2.86%.
As the deadline approaches, fund managers are sanguine about the impact of Brexit on their markets, or at least, want to give the impression they are.
“Brexit is having much less of an impact than the pundits predicted,” asserts Richard Shepherd-Cross, manager of Custodian REIT (CREI).
“There is no question that the uncertainty of the outcome of Brexit negotiations is creating some disquiet, but the day-to-day pressures of a normal property cycle are still having a much greater impact on the market.”
Calum Bruce, investment manager at Ediston Property (EPIC), believes the uncertain market will throw up opportunities to exploit, as investors adopt different stances on key issues.
The one fear for investors in open-end funds, as Ben Yearsley, director at Shore Financial Planning, notes, is they will run into liquidity problems once again if values fall sharply on a Brexit shock. But Adrian Lowcock, head of personal investing at Willis Owen, thinks they have learnt the lessons of two and a half years ago and gating is less likely to re-occur.
Jason Baggaley, manager of Standard Life Property Income Trust (SLI), agrees and cautions about panic selling. “We went to an 80% discount the day after Brexit," he reflects. "It wasn’t a great day to sell, particularly as two days later we were back trading at a premium.”
Retail Remains Challenging
There are some clear challenges within UK property markets, with the change in consumer buying habits, from trips to the shops to online retailing, the obvious culprit. As a result, retail is not the place to be. It was, unsurprisingly, the worst-performing sub-sector in 2018, returning just 1.5%.
Baggaley says he bought retail units around four years ago before selling out swiftly two years later when it became “quite obvious which way it was going”.
Alex Ross, senior investment manager at Premier Asset Management, expects retailers to continue to shrink their physical estates and thinks we’ll see “some material write-downs in retail property valuations in the UK”. That said, the convenience retail segment could limit this impact somewhat.
Another sector that is seeing changes to rival retail are offices. Setting aside the Brexit uncertainty, which is likely to affect Central London rather than regional markets, the influence of US start-up WeWork is forcing building owners to re-think their strategies.
Companies are offering employees smaller desks, anticipating them spending less time sitting at them due to a growing will to work from home and a wish to sporadically work from break-out areas around the office.
More modern office buildings are also now likely to contain coffee shops, bars, showers and bicycle parks. “I’ve just put a yoga studio into one of them for a tenant,” says Baggaley.
But the Edinburgh-based manager says he’s steering clear of Central London offices, owning just one small building. Godding shares his worries here, and thinks we’ll see a softening in both office values and rental yields in the capital. In contrast, lower levels of construction have kept supply tight and vacancy rates below the 20-year average elsewhere in the country.
Following on from this, Baggaley says there’s more demand now for housing close to these offices. “Commuting is no longer favoured. If you’re a millennial, you want to be able to fall out of bed at about 10am and still be at the office on time.”
Industrial Sector's Stellar Growth Set To Slow?
The current darling of the property market is the industrial sector, which was the strongest-performing sub-sector, up around 16%. It’s the one area that’s benefitting from the decline of bricks and mortar retail, as online sellers look to build warehouses and distribution facilities.
Everyone loves industrial today, explains Baggaley. But, as any good contrarian manager will tell you, that’s never a good thing if you aren’t in the sector already. Aviva says industrial is well place, but current rates of rental growth “appear unsustainable”.
Baggaley agrees: “Pricing has got fairly eye-watering for good-quality industrial. It’s a great thing to own, but maybe not a good thing to be buying because you’re paying away your growth up front.”
Elsewhere, there are plenty of more esoteric areas in which investors can take advantage. Andrew Cowley, managing partner of Impact Health Partners, which managers Impact Healthcare REIT (IHR), says his trust’s space has good demand.
The number of people aged over 85 in the UK is forecast to double by 2040, he says, with around 15% of that age range in 2018 requiring the kind of care that can only be provided in a residential care home or hospital, where his fund invests.
Rogier Quirijns, portfolio manager at Cohen & Steers, agrees and says he’s bullish on retirement housing and healthcare properties, liking GP surgeries in particular.
“There is limited tenancy risk coupled with sustainable yields because the assets are funded by the UK government and demand is secular,” he explains. “At the same time, the structure of the lease contracts typically provides inflation protection.”
Where To Invest For Property Gains?
A key consideration for investors is whether to plump for an open- or closed-end fund. The illiquid nature of the asset class certainly lends itself better to the latter. The Financial Conduct Authority is currently reviewing its rules on open-end funds investing in illiquid assets.
While Lowcock, as previously mentioned, thinks suspension of open-end funds this March is unlikely, there is a risk it could happen again. He says: “Investors should think seriously about their exposure as they shouldn’t be investing in property if they might sell under a short-term issue.”
Baggaley says there’s no right or wrong, with some investors preferring the safety net of being able to cash out whenever they like. There are positives to the closed-end structure, though, he notes.
“The main one is that all I need to worry about really is shareholders’ best interests. Every decision I make is dictated towards what I think will give me the best return to meet the objectives of the company for shareholders, as opposed to being dictated in my strategy by cash flow.”
For those looking to open-end funds, Ryan Hughes, head of active portfolios at AJ Bell, suggests looking at Kames Property Income, which yields a healthy 5.2%. It was one of the few to remain open in 2016 and has delivered annualised returns of 4.9% over the past three years, he says.
Closed-end fund investors may wish to consider the Silver Rated TR Property Investment Trust (TRY). Morningstar analyst David Holder says: "
TR Property remains one of our highest-conviction ideas for active management within the Pan-European listed real estate sector. The management team gives significant cause for confidence."
