With global economic growth forecasts restrained, largely due to geopolitical issues, such as potential trade and tariff wars, as well as such geopolitical issues as Brexit, investors are looking to re-balance their portfolios. Given recent equity volatility in recent months and Quantitative Easing (QE) distorting returns in bond markets, property is increasingly being targeted as an attractive asset class. While both the commercial and residential property sectors do have issues, they still offer investors a solid store of value and, relative to current turbulence in equity and bond markets, offer the prospect of potential outperformance.
Below we analyse the recent performance of the property sector and reviews which of the various vehicles and funds as well as emerging property investment platforms, offer investors some of the best prospects of robust returns.
Challenging investment backdrop
UK commercial real estate investment reached £62.1bn in 2018, which was a fall of 5.7% year on year but a rise on the three-year rolling average of £59.8bn. Within the context of Brexit and slowing economic growth this was a strong signal that the UK property market remains an attractive proposition. While this overall figure was promising, it is worth noting that all sectors, aside from leisure and alternatives, saw a decline in investment and alternative property sub-sectors and mixed-use accounted for 29% of all investment, the highest proportion ever recorded.
In the residential market, recent regulatory and tax changes have damaged the buy-to-let sector and a housing market analysis by property experts Hamptons International showed investors spent £5.2 billion less on buy-to-let property purchases in the first half of 2018 than they had in the same period in 2015, a drop of 30%. Overall, however, the UK real estate sector has performed remarkably well compared to other global asset classes, with UK industrials leading the way with a 12 month return of 17.4%.
REITs should be handled with care
REIT’s are looking more and more vulnerable. Though they have had a good start to 2019, up 13%, on average their shares are trading at a 36% discount to Net Asset Value. Those with the most challenging outlook will have significant exposure to the high street and the retail sector. One REIT, which is already taking action to re-balance its portfolio is British Land REIT, which last month announced the £429 million sale of 12 superstores. Probably residential focused REITS are better positioned, though those focused on the Private Rented Sector (PRS) and sub-market housing have their own challenges.
Also, REITs are potentially on the verge of a tipping point. It is highly likely that investors are going to take a dividend hit in the near future. Headline rents have been maintained so far through booms in both fast-casual dining and flexible workspace but going forward will struggle to take the hit of falling retail and office space. With many REITs looking to cut debt going forward they are going to have to sell assets yielding much more than the QE money they were purchased with. This is likely in turn to lead to earnings dilution and dividend cuts.
Open ended property funds falling out of favour
Investors are increasing pulling out of this investment vehicle as the FCA continues to crack down. Increased regulation was inevitable after the panic of 2016. After the EU referendum result many investors wanted to sell their holdings, which forced managers to access their cash reserves in order to meet redemptions. When these reserves run out they are forced to sell properties quickly, often selling them at less than their market value, affecting investors still involved in the fund. As a result of this concern, investors continue to pull out of the sector with £336m being taken out in the last three months of 2018.
Real estate debt funds and co-investing with private equity pose risks
Both these two approaches have gained favour in the years since the Great Financial Crash. Real estate debt funds have capitalised on banks’ reluctance to lend to property developers, while private equity houses, with such a significant amount of dry powder have expanded their investment horizon from focusing on mainstream corporates to encompass property-related businesses too.
Largely debt funds require significant commitments, while private equity funds have taken a different approach. By offering HNWs and family offices the opportunity to invest on a deal by deal basis, rather than having to commit capital to a fund, some mid-market private equity firms allow investors to participate for as little as £25,000.
While debt funds back a variety of property developers across sectors, alternative property sectors, such as hotels and student accommodation, have been very popular with private equity co-investment strategies. Student accommodation capital values rose 6.5% last year while hotels continue to attract significant investment- last year Europe received the largest amount of cross-border investment, largely stemming from the Middle East and Asia.
P2P platforms focused on property gaining investor attention
P2P lending has grown year on year since the financial crisis and now surpasses £3bn in total lending in the UK, with property loans comprising a third of all P2P lending. Initially this was focused on the residential sector, in particular buy-to-let, but more recently there has been a move towards commercial property-based P2P loans. While concerns have been raised regarding impending moves by the FCA, more robust regulation will help the sector mature and attract serious, responsible investors.
Strong growth has been seen in bridge funding for mid-market builders and developers of flats for sale to buy-to-let landlords, or direct buy-to-let mortgage providers, as well as to commercial real estate lenders. However, a number of these areas have begun to stall. For example, changes to tax and stamp duty have led to investors exiting the buy-to-let sector.
More recently, the property aspect of P2P has seen fresh strategies evolve in response to changing market conditions. For example, our platform focuses on small-to-medium sized affordable projects, outside of London and the South East, where values are more restrained and the lack of funding options allows more competitive rates to be charged. While property remains a very attractive investment in these very uncertain economic times, greater care needs to be taken in assessing options to ensure investors secure the outcomes and returns they are seeking.