Conventional wisdom suggests property investors should avoid the UK due to the uncertainties surrounding Brexit.
Many market participants have issued grim outlooks on the prospects for UK property, particularly as growth has stuttered since the EU referendum almost two years ago.
However, this negativity is excessive. With interest rates still hovering at very low levels, there remains an abundance of investable capital seeking yield-generating assets.
The lower level of sterling since the EU referendum is also another positive for global investors.
The Cohen & Steers SICAV Global Real Estate Securities fund is currently overweight the UK, focusing on areas relatively insulated from the direction of the UK economy.
Importantly, the general scepticism surrounding the future direction of the UK economy has created opportunities in some segments of the market.
While the positive outlook is not widespread, a number of areas within the UK property market can continue to flourish throughout the Brexit negotiations and beyond.
One of the UK’s most valuable exports is higher education.
International higher education students contribute 10 times more to the UK economy than the hosting costs, with this contribution totalling in excess of £22bn in 2015-16.
We expect sterling to be structurally weaker following the EU withdrawal, which is supportive of an increase in international student numbers, as it lowers the cost of an esteemed UK education.
An undersupplied market, UK student housing has experienced dramatically rising demand over the past decade.
This dynamic indicates that the sector will remain compelling for some time to come.
The student housing space is also relatively insulated from the domestic economy, as student numbers have tended to stay stable throughout the economic cycle.
In the aftermath of Brexit, we do not foresee the UK government restricting student numbers.
As a result, we increased our allocation to the UK student housing market in the wake of the Brexit vote.
Tailwinds for industrial logistics
Exports should also be boosted by a weaker sterling level in the aftermath of the UK’s withdrawal from the EU.
Between February 2017 and the end of January 2018, UK exports rose 11.5 per cent to £626bn. Goods contributed significantly to this growth, with goods exports rising 12.6 per cent to £345bn.
Industrial logistics property should benefit from rising exports, particularly in the south east.
The large majority of the fund’s exposure is in the south east, which is where a significant proportion of goods flow out of the UK.
While exports have suffered a brief relapse in the first quarter of 2018 as sterling strengthened, this seems to be only a temporary shift and the pound’s bias is towards the downside.
As export-focused industrial logistics properties are largely reliant on overseas demand dynamics, this segment is also rather defensive in the face of any domestic economic downturn.
The sector is also benefitting from the tailwind of rising e-commerce.
The by-products of Brexit
Of course, the outlook for UK property is not universally positive.
The weakened sterling is particularly detrimental for UK retail, as import costs rise. This has prompted us to sell our exposure to this area.
A further point of contention is the UK’s position within the Single Market, particularly in respect to the financial services sector.
In 2016, financial and insurance services contributed £124.2bn in gross value added (GVA) to the UK economy, 7.2 per cent of the UK’s total GVA.
While financial services will likely be covered in the eventual trade deal between the UK and the EU, it will probably be much more restricted than the current system of passporting within the Single Market.
Any shrinkage of financial services will likely have a significant impact on the London office market.
Cohen & Steers sold its position in this area of the market ahead of the Brexit vote, on the view valuations had reached a peak. There is limited upside potential for rents in this market.
Following the capital flight
While any flight of capital and business operations from the UK would particularly damage the London office segment, other markets around Europe would be beneficiaries.
Amsterdam has surprised market observers by attracting a significant number of operations recently – including the European Medicines Agency and MUFG, Japan’s largest bank.
Amsterdam has compelling dynamics. It is a market with a relative undersupply of quality office space, which is helping to drive up rents and property values.
Other markets – including Frankfurt, Paris, Berlin and Madrid – are similarly set to benefit from attracting capital from the UK. Each of these markets currently have relatively low rents, leaving significant room for growth.
It is expected that a large number of financial institutions – alongside businesses in other sectors – will soon seek to firm up plans to deal with the UK’s eventual withdrawal from the EU.
These announcements should give a clearer steer on where the capital flows will be directed, as well as the markets likely to experience stronger rental growth.
Source: FT Adviser