The outlook for UK property


‘Headroom’ and a low volatility outlook. Lower volatility is also a feature of UK property industry forecasts. The IPF consensus for the five years to 2022 shows that total returns will remain stable in mid-single digits at an annualised 4.8% pa rate. This reflects very modest rental growth of 1.1% per annum and capital value growth of -0.1% per annum. Colliers International forecasts are roughly in line with the industry consensus, but show greater details with All Property yields drifting by around 10 to 20 bps before moving in again by a similar amount. This may happen despite an outward movement in bond yields from around 1.5% to 3.8%.


This apparent anomaly demonstrates the amount of ‘headroom’ that exists between All Property equivalent yields and the 10-year gilt rate. The difference between Q4 17 MSCI/IPD All Property yield at 5.6% and the 10-year gilt at 1.3% remains very wide at 430 bps. Much of the anticipated rise in gilts will be absorbed within that wide margin. In the period 2001 to 2007, the yield gap averaged 240 bps, suggesting that gilts would need to rise by almost 2% before any significant impact was likely.


Quantitative easing has little impact. Interestingly, the figures suggest that UK property pricing was generally unaffected by the 100 bps of yield compression that might theoretically be attributed to UK quantitative easing. Hence, over the longer term, any unwinding of UK QE looks unlikely to have any disproportionate impact on UK property. Low yielding prime and institutional grade assets would seem to be in the line of fire, but the ongoing global demand for safe haven assets looks set to hold pricing firm, even in the lower yielding market segments.


Sterling arbitrage remains supportive. Furthermore, UK property is also supported by an ongoing currency arbitrage that is not likely to disappear until the terms of any political settlement with the EU have become clear and are agreed. Sterling remains almost 10-15% down on its average level in the six months prior to the EU referendum. By various measures, sterling is understood to still be down by around 10-15% on long-term international equilibrium value. For an overseas UK property investor who expects sterling to revert to its long term value, this arbitrage works out to the equivalent of between 50 to 100 bps in yield depending on your existing yield.


In short, the outlook for UK property remains strong, buoyed on by many short and long-term factors. Increasingly, investors are looking beyond London into the regional growth cities. Since the early 2000s, international investors have invested successfully across the UK and this familiarity has widened the investible UK universe. Coupled with regional political devolution, the UK looks set to benefit from further expansion of international investment flows. The Brexit negotiations may have caused some investors to pause and take stock, but the very recent evidence suggests that international occupier demand for space in Central London and the UK has accelerated, even in the absence of a clear Brexit agreement.


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When will the tide turn on commercial property? MIPIM 2018 | Colliers International


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