MIPIM, March, 15, 2016 – In a report released today, global real estate advisor Colliers International explains why, despite ongoing political, economic and financial headwinds, the commercial property bull market rumbles on in search of a second peak.
In “A View from the Top”, Colliers International suggests that UK and European property markets, especially the core sectors, appear to be walking a tightrope, at a height in terms of pricing, but sentiment appearing to be neither rising nor falling in any convincing trend.
“Since mid-2013 the property industry has enjoyed a bullish market, however over the last six months since the Chinese share crisis, political, economic and financial volatility has given investors a cause for a pause.
“There looks to be considerable life left in this bull. Many of the property market drivers that helped to achieve record volumes and pricing in the UK and Europe remain unchanged and will go some way to keep property on the radar of international investors through 2016 and beyond,” said Walter Boettcher, Chief Economist, Colliers International.
What has remained consistent for property investors over the last 12 months?
Colliers’ report shows that while there is evidence to suggest a transactional peak in the UK in 2015, European volumes are yet to show any significant decline. Low interest rate expectations, the sheer weight of capital targeting property, high demographic pressure and the intensity of the international search for yield remain unchanged and continue to position property as a favourable investment.
“Despite ‘lift off’ in the US, base rates in five years’ time are anticipated to be less than half the level they were in 2007 at the property market’s previous pricing peak. This will have a positive impact on the weight of capital targeting property and the ability of investors to use ‘cheap debt’. We are seeing this globally.” Said Richard Divall, Head of Cross Border Capital Markets, Colliers International.
The global weight of capital targeting property remains substantial. Institutional investors have steadily increased their allocation to property from 8.9 per cent in 2013, to 9.6 per cent in 2015 and are expected to approach 10 per cent by end of 2016. Just a one per cent increased allocation across the funds is equivalent to a $360 billion increase in funds targeting property.
“With debt availability and affordability improving, far from the search for yield moderating in the face of increased risk, there is evidence to suggest that as the economic and financial volatility experienced in early 2016 passes, commercial property may be faced with a new episode of ‘risk on’ investing,” said Divall.
The paper also highlights that one of the least appreciated forces at work in commercial property is on-going demographic pressure. This is especially apparent for pension funds that face increasing pressure on to find sufficient returns to match the growing annuity liabilities of a rapidly growing, yet ageing population in Europe and increasingly in Asia too.
What changes are impacting the property market?
Since the beginning of 2016, economic and financial markets have proven to be very volatile, particularly in the equity and bond markets.
In this environment, investment into direct property for steady returns continues to make sense in comparison to other asset classes. For example; in December 2015 UK total returns on property exceeded equities by over 10 per cent. However the property market is not immune to fiscal market sentiment explains Damian Harrington, Head of EMEA Research, Colliers International; “Core property looks expensive by historical standards and with prime office yields in key European markets on average 75bps lower than at the previous market peak in 2007, this suggests that a substantial pricing correction could be in the offing. What is obviously different today is the underlying yield pressure. In 2007, ten-year bonds were roughly equal to prime office yields, but in early 2016 ten-year bonds are on average 2.75 per cent lower. Clearly, there is scope for core assets to continue trading at lower yields with little outward shift for some time - perhaps in perpetuity.”
The key impact of ‘full pricing’ of core assets is that future performance will not be linked to further yield compression. Instead, investors buying core assets will rely primarily on income and rental growth to generate returns. Investors who already own core assets look unlikely to sell as there is little chance to replace these assets with other core assets.
Where are the opportunities?
“Low interest rates has led to an unprecedented weight of capital looking towards real estate which has caused a large disconnect between capital markets and occupational markets. Although geo-political risks weigh heavily on investors’ minds, we at a stage in the cycle where the occupational markets need to catch up with the capital markets and hence why we are seeing a pause in Tier 1 markets,” said Divall.
Divall adds; “Brexit is causing more uncertainty to investors in the UK than expected with many pausing and watching. In addition to current high pricing levels in the UK, relative high cost of finance compared to Tier 1 markets in Europe is helping to see a shift of capital onto the continent as property fundamentals improve and investors continue to expand their global and regional real estate portfolios.”
As more long-term investors (20-30 years) have entered the market, the volume of available stock on rotation has diminished. The main impact has been to drive investors to look at ‘alternative’ property assets where competition for product is lower.
Boettcher said: “Direct investment into alternative property assets reached a new high of £28 billion in the UK in 2015, or 40 per cent of total direct property investment. This looks increasingly like a substantial structural change in the UK investment market.”
Harrington adds: “Across Europe the story is different, but perhaps surprisingly, not far off the shift to alternatives in the UK. By the end of 2015, residential investment surpassed industrial and logistics as the third most prominent form of investment after office and retail assets*.”