Since the EU referendum, my greatest concern in the short term has been the outlook for UK commercial property.
For the retail investor, the UK commercial property market appears to be the only asset class that has suffered in the post-Brexit environment, allowing for the initial panic in most major areas of interest and their subsequent rebound.
Even UK mid-cap, which one could safely argue is highly geared to the outlook of the UK economy, has made good all of its 2016 year-to-date losses and is now showing a modest gain as of early September. Should investors be expecting the same level of recovery for UK commercial property, and does it still deserve a place within a diversified multi-asset portfolio?
A word count prohibits me from giving a detailed synopsis of the open-ended retail UK commercial property market since the referendum, but buzz words such as ‘swinging prices’, ‘suspensions’, and ‘fair value adjustments (FVA)’ should ring some bells.
Focusing upon the likelihood of a recovery within the market, the standout positives are that banks are still lending, and that a lack of speculative development since the financial crisis has led to limited supply. This is compounded by office space converting into residential. Therefore, oversupply is virtually non-existent and the credit backdrop is benign.
There is also no sign of a buyers’ strike, something which was particularly apparent during the crisis. One should also remember that the retail market only accounts for around 7 per cent of the overall market, and anecdotal evidence, so far, points to a robust institutional market.
So should capital values bounce back? Unfortunately, this isn’t likely. Capital growth is not going to return in vengeance, but the applied FVA discounts will soften significantly and pricing will swing back from bid to offer, alleviating a substantial part of the capital falls witnessed.
As capital growth is off the table, many retail investors will be tempted to walk away from the asset class, but I believe this would be rash. I am not disputing that exposure to the asset class should not be reassessed, but an unconditional elimination is unwarranted. The UK now faces negative real interest rates and the possibility, although unlikely, of actual negative rates. For an investor seeking yield, the bond markets provide limited opportunities and equities look expensive.
UK commercial property will continue to provide an attractive yield, even when one adds in an illiquidity premium. An economic downturn would, of course, affect landlords’ ability to increase rents, but tenants are loathe to relocate in uncertain times and will continue to pay their rent before dividend and coupon payments.
Or, put another way, even companies that may find themselves in difficulty will still require premises to operate from and will have entered into a five- to 10-year lease agreement with the landlord.
I believe that exposure to another source of income will remain appropriate for those retail investors seeking yield from their investments; UK commercial property can provide this.
James Calder is head of research at City Asset Management
