Does Brexit spell trouble for UK commercial property?
Are we at the beginning of a downturn in UK commercial property, prompted by uncertainty following the Brexit vote?
Are we at the beginning of a downturn in UK commercial property, prompted by uncertainty following the Brexit vote? If so, how worried should investors be? Many long-term investors prize commercial property as a useful addition to their holdings that could help to offset the ups and downs in their share and bond holdings, while aiming to provide steady income and some capital growth. But the inevitable swings in the property cycle must also be taken into account.
There’s no doubt that following the referendum result the commercial property market paused as owners and tenants took stock of the situation. At the same time, other trends continue to play out, especially the fall in demand for retail units as online shopping grows.
Why commercial property moves in cycles – and what might happen next
All this shows how commercial property offers a good window on to the wider economy. When times are good, rents rise and developers build more space to meet growing demand. Once the cycle turns down, vacancies increase, development slows and rents stabilise or fall. As the UK prepares to leave the EU, uncertainty is likely to dominate and activity may slow, which could result in rent increases slowing and a levelling off in property values.
How resilient might commercial property prove in tougher times?
If that sounds fairly unattractive, there are many positives to consider too: a few companies have made strong commitments to London since the referendum and there are also ways in which an effective investment strategy can offset any slowdown.
The first point is that despite the pause following the referendum result, demand for commercial property seems steady. Rents remain stable overall, although tenants are seeking better terms on break clauses to retain more flexibility. Also, outside the retail market where many shop units are empty, vacancy rates in office and industrial space are low since there has been little new building over the past few years. That means there is no glut of empty units to depress prices. Fewer property owners have very high debt burdens now than before the last cycle peaked in 2007, which reduces the risk of stretched owners being forced to sell into a falling market and depressing prices further.
Equally, despite the Brexit uncertainty, big technology companies such as Google and Facebook have confirmed plans to expand in London to benefit from its large pool of skilled workers, and London is also becoming a global centre of excellence in life sciences, thanks to a series of recent developments including the Francis Crick Institute and Imperial College’s new campus.
How helpful are ultra-low interest rates?
Commercial property has also received a helping hand following the Brexit vote from central banks and currency markets. Very low bond yields engineered by the Bank of England, which cut interest rates again to 0.25% in August, have made the yield on commercial property look much more attractive by comparison.
In addition, the sharp drop in sterling immediately after the referendum has made UK properties much cheaper for international buyers. This has helped to bolster overall demand for commercial property even as domestic investors hang back.
Overall, these factors have helped to soften the downward pressure on the commercial property market, smoothing out the cycle and preventing a much sharper slowdown.
What’s our approach to this market?
Against this background, our property team aims to own properties in strong local economies that will continue to attract people and businesses, thanks to their excellent universities and high quality infrastructure. We include cities such as Brighton, Bristol, Cambridge, Leeds, Manchester, Oxford, Milton Keynes and Reading on our list of favourite locations. We also think certain areas of London remain attractive. By investing in vibrant and resilient local markets such as these, spreading our risks across different types of property and different regions, and making sure our rent reviews are spread out over a long period, we aim to counteract the unavoidable ups and downs of the cycle.
There is no escaping economic uncertainty over the next few years as Britain gets ready to leave the EU, but the effects on the commercial property market so far have been fairly muted and we believe the traditional attractions of commercial property for long-term investors remain intact: it could yield an attractive premium over government bonds, offers a good way to offset rises and falls in bond and equity holdings, aims to generate steady capital appreciation and – thanks to periodic rent increases – it helps to protect investors from inflation.
Why choose an investment trust for your commercial property holdings?
Finally, and importantly, commercial property is also an asset class where investing through an investment trust could make good sense because if times do become much tougher, the fund will not have to sell properties in poor market conditions if investors want to take their money out. This is because unlike unit trusts, investment trusts have a fixed pool of capital and investors own shares which they can sell if they want to withdraw their investment. This key feature allows the fund managers to take a more long-term approach to investing and to hold a portfolio that they believe has the ability to deliver despite short-term market turbulence.
The commercial property market is facing an uncertain period as Brexit unfolds, but it still has much to recommend it to long-term investors looking to spread their risks and find attractive returns.
Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them can go down as well as up and investors might not get back the amount originally invested.
For investment advice, speak to your Financial Adviser. If you don't already have an Adviser, you can find one at www.unbiased.co.uk or www.vouchedfor.co.u
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Past performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.
Issued in February 2017 by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.
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