Thinking thematically: the stars align for UK property

The article below was first published in EG on 6th July 2021. Access their on-line version here or read the full article below.

With the UK economy projected to deliver significant GDP growth over the next five years, underpinned by strong consumer spending trends, there is a firm foundation for increased occupational demand across all types of real estate.

The avoidance of a no-deal Brexit removed a major downside risk. UK business confidence is at a 14-year high and companies are likely to resume investment after adopting a “wait and see” approach in recent years. A deal covering financial services has proved elusive, but the UK has been diversifying away from finance since 2012 in favour of technology and professional services. Consequently, the risk to overall employment is lessening.

In addition, a clear pandemic exit strategy resulting from the advanced vaccination programme should facilitate a permanent exit from lockdowns and unleash significant pent-up consumer demand.

Exploit inconsistencies

Aside from economic fundamentals, there is a clear rationale for UK real estate investment. First, the real estate yield spread over gilts is extremely wide. Second, UK property appears under-priced relative to European markets. Brexit uncertainty meant the UK did not experience the yield compression seen on the continent prior to the pandemic, and for international investors, the reduction in hedging costs over the past 12 months will also make pricing more attractive on a relative basis.

Prime London City office yields in the final quarter of 2020 remained at Q4 2016 levels and were higher than other major European cities. In contrast, in markets such as Paris, Berlin, Munich and Madrid, prime yields have fallen below their Q4 2016 level, in some cases by up to 80 basis points. Alongside positive economic momentum in the UK, this pricing disparity, lower hedging costs and the lessening of Brexit uncertainty should support yield compression.

That said, the recovery may not be universal. The pandemic has hastened structural changes that have been evolving for several years and, as a result, the market is polarising rapidly. This is evident between sectors and within sectors, as different winning and losing locations and assets emerge in the face of shifting occupational demand. Even the logistics sector, which has delivered strong returns this year, is experiencing a widening gap in performance depending on quality as occupiers become more discerning.

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Think thematic

Against this backdrop, pursuing a forward-looking, thematically based investment strategy is more important than ever. This strategy should address three key considerations.

First, identifying sectors and locations that will benefit from the structural changes in our economy and those driving consumer and business demand.

Second, the specification that will meet the demands of the end user. It is no longer enough to own an asset in the “right” location, the asset itself must be aligned to thematic changes or have the capability to be adapted to meet these changing demands. For example, in the office sector, consideration should be given to key factors such as natural light, air quality, adaptability, smart building technology and the amenity offer.

Finally, as demand for a more flexible, service-led offer emerges across the real estate spectrum, investors must adopt a more operationally intensive management model. Investors with greater operational control of their asset can deliver a tailored product that is better aligned with the needs of the end user and will have more success in attracting occupiers, thus reducing voids and capturing rental premiums.

Our investment in Forge, Woking, a town centre office building (pictured), and its subsequent refurbishment was informed at all stages by our thematic strategy. Our analysis pointed to several characteristics of the town that suggested it would be resilient to structural change and in some cases would be a beneficiary. During the refurbishment the demands of the potential end user were carefully considered to inform the asset specification. Particular attention was given to the arrival experience, end-of-trip facilities, adaptability, flexibility, and the layout’s ability to support the development of a community within the asset.

Conditions in the UK real estate market indicate clear opportunities for growth. However, in a polarising market, the risks are numerous. To take advantage of this window, a thematically driven investment strategy and discerning stock selection will be critical.

Tim Munn, Chief Investment Officer - Advent Capital Investments Ltd