It’s approaching Christmas. While our minds may slowly be tuning in to that happy occasion — whether you are a Christian or not, we all like a festive season, even if there is an element of enforced jollity — the minds of property forecasters are taken up with projections for the year ahead. It’s an inexact science, forecasting, for none of us can foretell the future. But we can have fun trying.
Two forecasts last week for the U.K. commercial real estate market from two eminent commentators, Savills and Schroder Real Estate, contain fun news next year for Europe’s largest property market.
Savills is predicting that average total returns in 2016 will slow to around 7.5 percent and says that investors next year will focus on the income-generation potential of property subsectors. This may mean paying greater attention to unlocking the latent value of individual assets through active management and a further shift toward investment in regional markets, given that recent capital growth in London markets has left yields at record-low levels.
The United Kingdom’s planned referendum on membership of the European Union presents the greatest uncertainty for U.K. real estate in 2016–2017, according to Savills:
“The prospects for a pre-referendum investment slowdown may well depend on how close polling companies believe the outcome will be.”
Mark Ridley, CEO of Savills U.K. and Europe, comments that U.K. real estate will move into a new stage of the property cycle next year and will also face a number of “known unknowns.” These include the in-out E.U. referendum within the next 18 months, new regulation coming into force and a potential end to more than six years of record-low interest rates. Ridley says:
“As we’re unlikely to see a repeat of the strong capital growth witnessed recently, we’re predicting that investors’ attention will turn to maximizing rental growth and income returns. There are still numerous opportunities across all the sectors we’ve explored, however, particularly outside the capital, and we expect to see the shift toward investment in the regions that began this year to strengthen in 2016.”
For Schroder Real Estate, 2016 will see performance across different parts of the various real estate sectors become more polarized over the next 12 months. 2015 was a good year for U.K. commercial real estate, the firm says, with unleveraged total returns likely to be close to 15 percent. Duncan Owen, head of real estate, points to the impact of the broad-based recovery in rental values:
“While central London offices have led the upswing, several other cities including Brighton, Bristol, Cambridge, Manchester, Leeds and Oxford have also seen a significant increase in office rents.”
Owen concedes that some commentators are asking whether we are now at the top of the cycle. Capital values have risen by 25 percent in less than three years. “Surely, this cannot continue?” he asks. But he answers his own question:
“This sentiment is understandable, but not necessarily rational. The immediate trigger for previous downturns has been a recession, which has depressed rents and pushed up real estate yields as investors have withdrawn from the market and liquidity has dropped. In addition, commercial real estate has had a habit of contributing to its own downfall, either through excessive borrowing that inflated prices (eg. 2005–2007) or because of a boom in development that left an oversupply of space (eg. 1988–1990) and falls in rents.”
Things are different this time. Oh no they’re not. Oh yes they are. The economic outlook is positive and the consensus is that U.K. GDP will grow by 2.25–2.50 percent through 2016–2017. Also borrowing is under control and new commercial development remains at a low point in most markets. One exception is the City of London, where a number of new offices are due to complete in 2018–2019.
Schroders expects that total returns from U.K. commercial real estate in 2016 “will still be respectable, at between 7 percent and 9 percent.” One risk centers on 10-year government bond yields, where there is a possibility that these could jump more sharply in 2016 than anticipated. A second risk is the E.U. referendum:
“If the United Kingdom were to leave the E.U., then U.K. real estate could be hit as various investment banks and institutions, as well as some manufacturers, switch to continental European locations.”
Ho hum. Here’s another forecast. The Fed will increase interest rates this week. Oh yes it will. By a fraction of 1 percent. How big a fraction? Ooh, about t h a t big.
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Richard Fleming is editor of Institutional Real Estate Europe.
