Commercial property has been seen as something of a bellwether for Brexit. Within days of the referendum vote in 2016, deals were put on hold, valuations fell and commercial property funds were forced to drop the portcullis to stop investors leaving in their droves.
Once nerves had settled, valuations recovered and funds re-opened for business. But there’s a lingering feeling that if Brexit goes badly, it could all happen again. Even if the negotiations are successful, some believe property will suffer a greater impact from Brexit than the economy as a whole.
For investors looking to property either to provide a stable income or to diversify their asset base, this presents a conundrum. Perhaps it’s time to stick with real estate, but look outside the UK?
The case for doing so has several strands. First, there’s the anticipated impact of Brexit itself. This is most likely to be felt in the office segment. Many companies, especially in London, are making contingency plans to move some of their staff outside the UK. But the retail and industrial sub-sectors could also be affected if Brexit leads to a general economic slowdown.
Secondly, there is the treatment of overseas investors. In the November Budget, chancellor Philip Hammond outlined plans to make overseas investors in UK property pay capital gains tax. JPMorgan Chase analyst Tim Leckie was among those pointing out that this could have a negative effect. ‘If implemented, this could drive a price correction through the market,’ he wrote in a client note.
Thirdly, there is a perception that better opportunities are available elsewhere. London is already top of the property price league table across Europe, and any loss for London is likely to prove a gain for Frankfurt, Berlin, Amsterdam or Paris.
There is some limited evidence that investors are switching allegiance from the UK to Europe: a poll by property portal BrickVest in November found that Germany had taken over from the UK as the preferred market to invest in, while Savills reported a similar picture in its European investment briefing in August.
However, financial advisers and asset managers are quick to point out that UK property funds are to some extent already priced for bad news. Russ Mould, investment director at AJ Bell, says: ‘Investment trusts such as British Land and Land Securities are already trading at 25-30 per cent discounts to their net asset values, so contrarians might see value there.’ He adds that the UK has significant advantages over other parts of the world in terms of governance and legal structures.
Jason Hollands, managing director at Tilney Group, says there are good reasons to stick with the UK if you choose carefully and avoid the funds most exposed to Brexit. ‘My view is that the outlook from here is a mixed picture, with some parts of the UK commercial property market positively underpinned by structural trends and others more vulnerable to ongoing Brexit related uncertainty and medium-term economic headwinds,’ he says. Industrial is a particularly attractive segment, he adds, especially warehouses, with the move to online shopping.
Moreover, European property funds face difficulties of their own. There has been a huge inflow of funds over the past few years, prompted in part by investors looking for reliable yields in the era of quantitative easing, and this has caused some inflation in property and property company valuations. That prompted Fidelity to suggest last summer that the market ‘has all the hallmarks of a bubble’.
James Yardley, senior research analyst at Chelsea Financial Services, says: ‘The thing to be worried about is what the European Central Bank might do next. Yields have fallen on all assets, including property, because of QE.’ A change of policy by the ECB could have a big impact on asset prices.
Looking beyond Europe, Mould says there is a stronger case for investment property in Asia. He adds: ‘There is less debt and better demographics.’
However, for those looking for global opportunities, the picture is mixed. The MSCI World Real Estate index, which is quite heavily weighted towards the US, returned just 3.79 per cent in 2016 and 1.05 per cent in 2015, following a 15 per cent return the year before.
For those who have stuck to UK property, there is a whole world out there that becomes more attractive as Brexit progresses – although dumping well-run UK funds might be a rash move for now.
Property trust and fund tips
Legal & General UK Property (income)
TR 1 year 9.1%, 3 years 21.2%, yield 2.4%
Legal & General UK Property was one of the few big funds that kept its door open after the Brexit vote in 2016 caused a rush on property funds. Thanks to its cautious approach, with nearly a quarter of its £2.9 billion in assets in cash, the fund weathered the storm. John Husselbee, who is a fan of the fund, comments: ‘The larger, well resourced funds are probably best equipped to provide access to direct property, albeit with diluted exposure to provide the short term liquidity for those who want out at short notice.’
Kames Property Income (income)
TR 1 year 7.3%, 3 years 21.4%, yield 4.8%
This fund offers one of the highest yields on offer within the gamut of open-ended property funds, at 4.1 per cent. Brian Dennehy points out that another plus is that the fund is focused on the property market outside of central London and the South East, two areas where growth looks more challenged than elsewhere in the UK and indeed is arguably most vulnerable to a correction at some point.
TR Property (TRY) (growth and income)
PTR 1 year 36.2%, 3 years 47.5%, discount -3.4%, yield 2.9%
TRY is the only trust investing predominantly in property shares, and has outperformed most direct property trusts over most periods. Two thirds of its portfolio is in European companies, and the balance is in the UK, including some physical property. Jean Matterson believes property continues to look attractive, as rents in selected sectors are gently rising and the demand for good modern buildings exceeds supply. She says: ‘The discount has narrowed since I tipped it last year, but I still like the asset class and the European area.’
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