Recent headlines do not tell the full story about the commercial property market, argues Phillip Gadsden of Orchard Street.
Now that the initial market shock of the Brexit referendum result is over it is perhaps timely to review the impact of the vote on the UK commercial property market.
In summary, not much has changed. Sentiment in most letting markets outside the City (where occupiers are mostly finance industry-related) has remained largely positive. There are no indications yet of any significant fall in demand and most occupational deals that were negotiated before the referendum vote have completed as planned.
Some two months after the referendum, the consensus is that valuations are down across the market by on average between 3-5%. The valuation falls have not though been symmetric across all sectors and regions. Valuers have effectively increased the risk premium for short leases, vacancy and development projects and therefore values for higher risk properties have been hit hardest. Conversely, good quality properties let to good covenants on long leases have been relatively unaffected. For example, the portfolio of garden centres acquired for St. James’s Place late in 2015, which are let to Wyevale Garden Centres Limited on 25 year leases with rent reviews geared to RPI, have seen no reduction in value since the referendum.
The small fall in property values is probably as much to do with uncertainties caused by the referendum as it is the number of investment transactions ongoing currently, which are always low during the summer months. There have been a small number of well-publicised sales by open-ended funds scrambling for cash to meet redemptions, but it has been a tough job for valuers to interpolate underlying value movements when these deals, which involve ‘motivated’ sellers, comprise the bulk of the evidence. However, this scramble for cash has proved a relatively short-term phenomenon and has been stemmed by a number of property funds closing for redemptions to allow for sales over a more orderly period.
It’s worth revisiting the story behind recent headlines about the suspensions of several high-profile property funds, which were triggered by a surge in redemption requests immediately post-referendum.
A number of wholesale investment groups use a range of open-ended funds to gain property exposure for their multi-manager funds. When they decide to exit one fund holding, they tend to exit them all. The underlying funds then needed to act broadly in lock-step, introducing pricing adjustments largely simultaneously, then many decided to suspend the funds altogether. The alternative would have been a fire sale of property assets when the level of redemptions threatened to outstrip the cash available; something clearly not in the interests of their long-term investors.
It is an important distinction that the St. James’s Place property funds are only available to individual investors who are clients of St. James’s Place, therefore the funds are not subject to the potentially damaging impact of these institutional fund flows. While St. James’s Place introduced temporary pricing controls, there was only very limited pressure on the funds. The elevated cash levels in the funds also helped, which were a consequence of our cautious investment approach ahead of the referendum.
The decision to suspend trading in a number of the open-ended funds has had the effect of calming the market, but it remains to be seen what will happen when redemption restrictions are lifted.
As we’ve observed previously, whilst Brexit has introduced uncertainties into markets, the property sector is starting from a reasonably strong position. The market is not over-supplied, nor is it over-leveraged, in stark contrast with the period leading up to the global financial crisis. Being much better capitalised, the sector should be more able to withstand any economic shocks that might be down the road as Brexit unfolds. Another way of looking at it is that a better capitalised market is likely to be a less volatile market.
Of course, in the long term, property investment is about income received from tenants. The sector yields circa 5%, which is very attractive both in terms of quantum and long-term stability. This represents a significant premium to many other asset classes, in particular gilts which are at or around an all-time low. This yield premium continues to underpin investor appetite for UK property. Furthermore, since Brexit the fall in sterling has made UK property some 10% or so cheaper to overseas buyers, which is why there have been several reports of overseas groups now looking closely at investing in the UK market.
Clearly these factors will not entirely insulate the property market from any economic and political headwinds that Brexit may generate, but it is better to go into a period of uncertainty from a position of relative strength.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The St. James's Place Property fund has a deferred redemption period, transactions may be delayed for up to 6 months. Property market values are based on valuer's opinion rather than fact.
The opinions expressed are those of Phillip Gadsden of Orchard Street and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research or advice. The views are not necessarily shared by other investment managers or St. James's Place Wealth Management.