MSCI: structural changes flip generation-length performance trends

In the final part of this three-part series, we consider MSCI’s Q4 2018 data may indicate an inflection point for the UK commercial real estate cycle, driven by shifting demand for industrials and logistics relative to the retail sector.

This demand shift towards logistics is of course a global trend but one which is particularly pronounced in the UK, driven by jurisdiction’s high ecommerce penetration.

Speaking to Real Asset Insight, Will Robson, Global Head of Real Estate Solutions Research, MSCI explains:

“As you approach the latter stages of a cycle, you tend to see the yield spread between high and low yielding locations and sectors narrow as investors move up the risk curve in search for value and yield as assets gradually become more expensive. Before the financial crisis, for example, we saw the narrowing of that spread in equivalent yields.

“What is different this time around is that what we are seeing is more than just a cyclical rotation from low yielding sectors into higher yielding sectors. The natural order of sector yields has flipped: historically, industrial is the lowest yielding, followed by offices and then retail – that has been consistent over time and across markets. By the end of last year, retail yield had expanded to be the highest yielding sector, with industrial the lowest and offices keeping its middle position among the three core sectors.

“It is a combination of the normal cyclical rotation exacerbated by the powerful structural forces driving demand shifts for industrial and retail underpinned by ecommerce.  How much is fundamentals and showing up changes in rental growth and how much is investor sentiment is difficult to delineate.”

Retail’s underperformance, relative to the rest of the UK real estate market, is a stark contrast to the synchronised downturn during and after the worst of the global financial crisis. Indeed, there are still pockets of resilient performance, predominantly in London. Retail in the City of London returned 6.8% in 2018, followed by the West End and Mid Town, at 6.0% and 4.8%, respectively. By contrast, the West Midlands and Yorkshire & Humberside slumped most, at -5.0% and -4.3%, respectively.

All but one of the 13 location segments for the industrial and logistics sector returned annual total returns in the double-digits, including six above 15% (three of which were above 20%). Perhaps surprisingly, the star performer by location was Northern Ireland, at 23.8% (though this potentially is reflective of a small asset sample).

Offices were relatively consistent, with the regions outperforming London reflecting the degree of yield compression already seen in the capital and the greater handbrake on rental growth due to lingering Brexit uncertainty.

james.wallace@realassetmedia.com