The U.K. commercial property sector is entering 2020 with something of a skip in its step. The election of Prime Minister Boris Johnson's Conservative government with an 80-seat parliamentary majority in December 2019 was welcomed for providing some long-awaited certainty on the country’s departure from the European Union and its economic direction.
Brexit uncertainty was not as damaging to the sector as many had forecast and feared, a cause for further cheer. Both the investment and occupier markets have held up well over the last 3.5 years across every asset class except retail, where structural changes have eclipsed political concerns.
Having survived largely unscathed, the U.K. real estate sector can now look forward to a year when previously cautious investors and occupiers move ahead with acquisition and growth plans. International investors who had harbored Brexit concerns particularly are likely to be at the forefront of any rush back into the market, Mat Oakley, head of research at real estate services firm Savills, said in an interview.
"There undeniably were some investors staying out of the U.K. in 2019, in particular, because of political uncertainty. And they would probably most notably be core and core-plus institutional investors from Europe and Japan," said Oakley.
"Some will return to the market because political uncertainty has diminished; some will return to the market because U.K. prices haven't really moved [higher] in concert with those in Asia-Pacific and Europe because of Brexit uncertainty," he added.
The relative weakness of sterling as a result of Brexit uncertainty over the past 3.5 years made U.K. real estate prices attractive to international investors in comparison to other major markets. During that time sterling has traded as much as 16.0% lower against the dollar, and 15.7% lower against the euro, than it did immediately before the 2016 EU referendum.
Guy Grantham, director of research and forecasting at real estate services firm Colliers, said international investors are keen to enter the market before sterling strengthens any further from those August 2019 lows. "Currency movements are utterly critical to any overseas money, and that's what they're really looking at. There's a real concern that if they don't get in there, they are going to miss the boat," he said, adding that investors from Malaysia, Singapore and Japan are among those eager to make acquisitions.
Tight yields across other European markets are further likely to drive investors to the U.K. in 2020. Central Business District office yields in Europe’s major cities are averaging 3.45%, with popular markets such as Paris offering 2.90%, Berlin 2.80% and Amsterdam 3.00%, according to data for the third quarter of 2019 from Savills. Meanwhile, investors can get office assets in London’s West End at an average of 3.75% and the City of London for 4.00%, the data showed.
"London looks very cheap compared to other competing centers and there is a tremendous weight of global equity chasing real estate and chasing returns at the moment," said Grantham.
Much of that capital will be targeted at "big, dry, risk-averse assets," said Oakley. "So it's going to be well-let London office buildings, maybe a few big regional office buildings, and logistics assets."
Still, investors face a struggle to pin down deals as an increasing number of buyers chase down a limited number of assets on the market, Oakley added. "This might lead to some selective price rises in the most institutional parts of the U.K. property market in 2020," he said.
The shortage of investment opportunities, particularly in London offices, could be enough to prompt significant movement in the development market. Mitsubishi Estate Co. Ltd.'s decision to commence work on its 50-story 8 Bishopsgate project in the City of London in 2019 was evidence of investors' restored faith in the market, said Grantham.
"We're certainly starting to see some big [building] permissions come through for tower schemes in the city that have been on the drawing board for quite some time," he said. "Overseas money, which may not necessarily have the expertise or the experience to take projects forward, is now getting involved with local expertise such as Aviva PLC and M&G Real Estate who know how to bring these projects forward. And I think there's a real confidence [among investors]."
A hard sell
While such positivity is distinctly absent in U.K. retail property, 2020 might well see a turning point for some segments. Oakley expects to see transaction movement in the retail warehouse market as investors increasingly appreciate that such assets are better insulated from the structural change besetting the sector.
He also predicts that prime shopping center prices will bottom out this year following a two-year period where yields have moved out from 5.75% to 7.25% at the end of 2019. "Something will happen in 2020, and I think it will be a major opportunistic investor coming into the U.K. market who likes the fact they can buy prime at 150 basis points or more higher than they would have done two years ago," he said.
Still, any newfound exuberance in the U.K. property market following December's election result might well be tempered as the year wears on — and political risk rears its head again. Prime Minister Johnson has put a December deadline on the U.K.'s negotiation of a trade deal with the EU, which many experienced observers believe will increase the chances of the talks ending without a deal in place.
Investors' confidence is likely to be tested the closer the deadline gets, said Walter Boettcher, chief economist at Colliers. "You know the negotiations will go right down to the wire," he said. "And I'm concerned that the closer we get to the end, the press will inflate any difficulties between the U.K. and EU, and then maybe that will put investment off a bit."