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What does 2018 have in store for commercial real estate?

By Paul Norman - Tuesday, December 05, 2017 11:00

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Secure long-life income streams are going to be ever more highly prized by real estate investors over the next five years, Savills reported this morning in its much-anticipated annual curtain raiser forecasts for 2018, which predicted income returns will account for just over 60% of total projected returns from UK property assets for the period to 2022, compared to 45% over the last 10 years.

Unveiling its predictions for the UK commercial, residential and rural real estate sectors at its West End offices in its cross sector briefing this morning, the agent said that while Brexit and uncertainty over the UK’s future relationship would inevitably cast a shadow over economic growth next year leading to a more cautious investor outlook across all real estate sectors, investment will not stop, with new opportunities emerging and being targeted.

Savills said it expects capital growth to account for 40% of total returns across all UK property to 2022, compared to a 55% share over the past 10 years. This is reflected by the real estate advisor’s muted capital-growth forecasts at this stage in the cycle, as investors become more cautious on rental growth prospects going forward.

Urban logistics sit at the top of the Savills league table (see below) for average annualised returns between 2018 and 2022 as the sector looks set to deliver both the highest income yield and strongest capital growth prospects. According to Savills, not only is the secure income from the sector “incredibly popular at the moment”, but pressure on land, particularly inside London from other uses, will maintain undersupply and deliver extra rental growth.

The best performers in the residential sector are likely to be multifamily assets in regional cities.

Savills said that these offer an opportunity to capture higher yields with good prospects for underlying capital growth while corresponding higher-income yields should underpin performance in this part of the housing market cycle.

In the rural property market, uncertainty from the decision to leave the EU and around future agricultural policy is “impacting sentiment”, but nonetheless Savills expect units of scale which have options to diversify income away from agricultural production to remain sought-after.

Mark Ridley, chief executive officer, Savills UK and Europe, said: “The overall trend for UK real estate in 2018 is the continued transformation of risk aversion into resilient demand for prime assets. Domestic investors are likely to remain more cautious due to home bias, and perhaps a slight over-preoccupation with UK political issues not shared by their international counterparts, but although sentiment and activity may be subdued it won’t stop. UK property remains a safe-haven for capital preservation, and demand for prime, secure investments will be as keen as ever.

“The biggest beneficiary of the shortage of prime mainstream stock will be the UK’s plethora of income-producing assets classes, previously categorised as alternatives but will now firmly be in the mainstream. Whether a pub or cinema, warehouse, student housing, or the growing number of build to rent units being delivered, the attraction to investors will be the bond-type characteristics of the asset.”

Opportunities abound

In markets where risk aversion has become the overriding theme, Savills said that in the commercial property space there seems much less room for yield compression than the recent past while in the residential sector, mandatory stress tests will constrain the amount of debt available to buyers, and uncertainty over the extent and nature of future support for agriculture has already made buyers of rural land more cautious and increased the land market’s sensitivity to price.

Commercial particulars

Savills reports that the key opportunities in commercial will be driven by non-domestic investor demand continuing to expand out from London with renewed enthusiasm for segments that fell out of fashion in 2016 and 2017 due to the negative impacts of the weakening of sterling. UK property still offers comparatively strong returns and lower risk against other geographies, and this will underpin demand from overseas buyers it says. Its top picks are:

Urban logistics - Strong tenant demand and competition for sites from other uses will ensure strong rental growth.The strongest growth will be inside the M25, but Savills expects to see this spreading to big regional cities.

Affordable offices - With business uncertainty rising in the face of Brexit, Savills expects that “clever property decisions will be popular with occupiers. The best locations will be accessible and affordable, it says.

Savills' head of European commercial research Matt Oakley said: “Any investment branded as core, prime, or secure will remain hotly sought-after, and the quirks of the UK commercial property lease mean that, in comparative terms, we will always look less risky than some other domains, regardless of local political issues such as Brexit.”

That said Oakley says domestic investors are “likely to remain cautious in 2018 because of home bias, and also as they tend to see local political issues as more important than they actually are”.

Oakley adds that the biggest beneficiary of the shortage of prime mainstream stock will be the “plethora of income-producing assets classes that used to be lumped together as alternatives”.

Whether that asset is a pub or cinema, warehouse or student house, the attraction to investors will be the bond-type characteristics of the asset, Oakley reports. He says 2018 will be the “year that alternative becomes mainstream”.

Savills’ core pick for high returns remains development or asset management across all subsectors of the commercial market or “namely, turning short, risky income into long, secure income”.

In additions Savills says that there are areas for instance with relation to the impact of internet shopping on retail or Brexit on London offices where there are opportunities for investors to behave counter-cyclically.

Other key picks are:

Value beyond prime – With risk averse capital the dominant theme there will be “less competition and even falling prices in secondary and tertiary markets” and this will be a great opportunity for value-add and opportunistic investors as they “turn short income into long”.

Retail therapy – For 2018 Savills will see “better news about real earnings growth, and a less homogenous attitude to retail with investors”. Savills reports: “Some segments will be a good buy due to their defensive characteristics, while others just look cheap.”

New tech tools – Savills says that “some businesses will start to look at offsetting the costs of delivering wellness by using the margin-enhancing tools of artificial intelligence (AI)”.

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