The unexpected political events of 2016 will lead to a rise in caution and risk aversion among real estate investors in 2017, making secure income streams more highly prized among core investors globally. This is expected to benefit the UK market, where high levels of transparency and stable legal structures make real estate a safety play, says Savills.
The overall story for UK real estate is one of slower growth. Average UK house prices are expected to remain stagnant in 2017, before rising by 2% in 2018 and 5.5% in 2019 to a total of 13% by the of 2021. A supply/demand imbalance means rents will outperform house price growth, rising 19% over the same period.
In the commercial market, average total returns on UK property investments are likely to be approximately 5.6% per annum during 2017-2021, with a 1.6% five year capital growth forecast for office values and a 4.4% growth forecast for office income returns. Savills also forecasts 32% average five year capital growth for GB forestry and 5.5% average five year capital growth is forecast for GB farmland.
Commercial property assets with long lease structures and strong rental covenants will continue to attract attention, while institutional investor appetite for large residential portfolios is expected to continue to grow. The relatively high yields and strong income flows from commercial property will continue to attract strong demand, says Savills. Greater risk will mean a strong focus on sectors where the fundamentals of supply and demand are most insulated such as retirement housing, logistics and energy.
For opportunistic investors the continued ultra low interest rate environment will limit the extent to which distressed assets hit the market. These investors will instead look towards development markets, particularly mixed use opportunities linked to infrastructure improvements. The changed attitude to risk is likely to mean a less crowded market place for the value-add investor, particularly if lender caution results in tighter borrowing criteria in the development sector.
Mark Ridley, chief executive officer, Savills UK and Europe, says:
“'Expect the unexpected’ is now the normality, not the exception, on the world stage. Despite this, property remains a fundamentally safe asset class, giving strong income returns and, in many cases, is a refuge for capital preservation in the longer term, its appeal remaining resolute.
“Nationally, the markets continue to appear robust in all sectors, although there remains some hesitation on what Brexit will mean in the financial markets, around biomed and also in an agricultural market place without EU subsidies. The sterling devaluation has made UK property very attractive for international investors pegged to the US Dollar or Euro, with 2017 activity in Central London likely to be dominated by Asian investors, with American and Pan-European investors also strong nationally.”
Commercial predictions for 2017 and beyond:
- Uncertainty, rising demands from pension funds, and low bond yields will continue to drive a global hunt for investments that deliver secure income. This will lead to strong demand for properties in the UK that have such characteristics, whether they are long-let City offices, index-linked warehouses, or ‘alternative’ asset classes. Demand for such assets is likely to exceed supply, and Savills expects to see improving capital value growth
- Lender and borrower risk aversion will lead to a 30-40% fall in development activity across all sectors and regions, particularly in London, challenging tenants with forthcoming lease events but presenting an opportunity for developers prepared to press ahead with projects
- Tenants may demand greater flexibility when signing leases but occupational demand will be maintained. Declines in development activity, which are likely to be most intense in 2019-21, will lead to falling Grade A vacancies and rising rents towards the turn of the decade
- Non-domestic investor interest in the UK will continue to rise, with the next five years likely to see record levels of international investment in assets outside London
- Specific opportunities are available in logistics warehouses in strong locations such as the Midlands and the M25 area. With availability at record lows and demand unaffected by the uncertainty, this sector looks likely to continue to out-perform the rest of the market due to its long and often indexed leases, as well as the landlord-friendly dynamics in the occupational market
- High quality regional office assets should also perform well. Generally less affected by post-referendum uncertainty, availability in many markets is low, particularly of new and refurbished space, while demand is likely to remain high, supported by some large organisations continuing to relocate some functions from London
Residential predictions for 2017 and beyond:
- Average house price growth will be low over the next two years, but an extension of the low interest rate environment will prevent a price correction. Mainstream house price growth is likely to rise 13% by 2021, with East of England the top performer at 19%, the North and Scotland averaging just 9%
- The EU referendum vote has compounded the stamp duty effect on prime residential property, signalling two flat years before a return to trend growth in 2019. Prime markets are likely to outperform the mainstream over the next five years to the end of 2021
- Transaction volumes will fall 16% over the next two years, recovering to 2016 levels by 2021, but individual buyer groups will be impacted differently. Lower transactions are expected to continue driving demand into the private rented sector from frustrated would-be home owners
- Opportunities for private investors lie in restoration projects in the commuter belt where value can be added to take advantage of the price gap between London and elsewhere, and buy to let properties in university towns where student lets offer good yields and where values have been slow to recover
Agricultural predictions for 2017 and beyond:
- Low commodity prices and patchy local demand continues to affect the land market. Despite the benefits of the weak pound on outputs and subsidies, Savills expects the average value of ‘all types’ of farmland to remain under some pressure in the short term as current debt in the industry filters into sales
- Debt pressure is the single biggest factor which has the potential to increase supply. Debt related sales could be in the region of 20% to 25% of all transactions in 2017 but the effect will be tempered by the increase in 2016 subsidy and the positive effect of the weak pound on output prices
- The rental market will remain under some pressure but this will be alleviated by the scarcity of land to rent and demand from those looking for efficiencies through economies of scale. The subsidy review in 2020 will cause great uncertainty and affect the number of potential bidders for new rental opportunities
- The impact of the UK’s vote to leave the EU on farmland values is likely to be muted. The weak pound creates a favourable buying environment for overseas purchasers and, for those willing to venture from traditional assets, farmland offers the opportunity to diversify portfolios. This, along with the potential reduced supply driven by uncertainty, will help support farmland values. Long term fundamentals still apply with increased food production (balanced by reduction in food waste) and competitive land use driving demand supported by a favourable tax regime
- The prospect of a longer term upward trend in UK timber pricing structures remains very real, therefore making forestry an attractive asset. An excellent alternative land asset for long-term portfolio diversification and wealth preservation, well-managed commercial spruce forests with good access to timber markets will remain in strong demand, supported by the weaker pound and domestic demand from the construction industry