International capital stays away as Continental rivals fare better, but positive signs return at year end, reports Nicol Dynes.
The UK at the end of 2020 is a mixed market that is attracting a lot less foreign capital than usual. There is a mood of caution among investors across Europe and indeed the world. But now that cross-border capital is unable, or unwilling, to invest, the UK is paying the price for the dominant role that foreign investors have played.
“Capital market transactions are down 40% this year, which gives you an idea of how quiet life is,” says Stephanie McMahon, senior director, head of research, at BNP Paribas Real Estate UK. “In central London, office take-up is down 70% on last year. It’s a provisional figure but it shows where we are, even if the market will pick up at the very end of the year.”
“Markets are in risk-off mode in general, but the big difference between the UK and Germany or France is that in these two countries domestic capital is very active,” says Tony Brown, global head of real estate at M&G Real Estate.
‘The reality is that there’s limited cross-border capital coming into the UK at the moment.’
Tony Brown, M&G Real Estate
Investment volumes in Germany are likely to be higher this year than in 2019 and even in France record yields are being paid for Paris CBD assets. “That is a big contrast to the UK, where we’ve seen a lot less investor demand,” says Brown. “It is difficult to tell if it’s sentiment, Brexit or the practical impact of travel restrictions, but the reality is that there’s limited cross-border capital coming into the UK.”
There are positives, he points out, as there is a lot less competition in the market and proactive investors can buy prime assets more easily.
While there are big differences between the UK and its Continental peers, there are also differences within the UK itself. “We see a very polarised, disaggregated market,” says Mark Haywood, partner at CMS. “Investment volumes are down 35% on the 10-year average, but the industrial sector has never been stronger. A lot of what is on our desk now is industrial deals, anything from £50 million to £500-£600 million.”
The next priority for investors, he says, is the living sector – from healthcare and student housing to regional PRS investments. An example is the four 64-storey Renaker towers in Manchester, with 1,500 apartments.
“It shows the level of interest in build-to-rent, but also the shift to regional cities,” says Haywood. “London has become more expensive and difficult to live in, while the regions have become a lot more attractive.”
There are two question marks over the UK market, say experts. The first concerns investor appetite over the longer term: “The real attraction of real estate for most investors is the level of income compared to other asset classes, because it provides returns you can’t get anywhere else,” explains Brown. “But if rents continue to be unpaid for a long period, investors’ perception could change and they could question whether the risk premium for real estate is appropriate.”
‘Maybe there will be tectonic changes in terms of space requirements, but it definitely will not be the death of the office as predicted by some.’
Mark Haywood, CMS
Institutional investors have been patient, with pension funds retaining and in some cases even increasing their allocations to UK real estate.
The cash-flow crisis due to non-payment of rents has been seen as a temporary problem, but it cannot go on for too long. “Long-term investors are patient, but up to a point,” says Brown. “I see this as the biggest risk.”
The other question mark is over continuing government support to long-lease covenant products, given the economic slowdown and increased, record levels of debt incurred in the last few months to finance employment support schemes.
“Government-supported covenants have been positive for the UK market,” says Haywood. “Many schemes have been underpinned by some mix of income strip lease commitment, prudential borrowing or old-fashioned grant funding. The question now is, will it continue or will the purse strings be drawn because of financial constraints?”
Local authorities taking 35-40-year leases has been good for pension funds, which have benefited from inflation-linked cash flows over a long period of time.
“Thanks to this support we’ve been able to fund regeneration schemes in the north of England, even in zones with low economic activity,” says Brown. “There is huge demand from domestic pension funds still for that type of product if we can get the structures put together with government bodies, so it will be quite important over the next few years.”
Investors who look beyond the short-term continue to believe in the office sector, says Brown: “Demand is likely to be an issue for the next couple of years or so, but beyond that my view on the office market is simple. I fundamentally believe that people will still want to work in offices for collaboration and brainstorming.”
The pandemic has forced people to work from home and had a negative impact on demand, with take-up in London sharply down this year. But in the long run the crisis might have worked in the sector’s favour.
“In some respects the office has become even more important,” says McMahon. “Do we need the same amount of space? Perhaps not, and that will play out over the next couple of years.”
But after months of remote working people, especially the young, value more than ever the experience, sense of community, supervision, training and mentoring opportunities that offices can offer.
‘Do we need the same amount of space? Perhaps not, and that will play out over the next couple of years.’
Stephanie McMahon, BNP Paribas Real Estate UK
“I have been surprised to see that the resilience of the office has been strengthened,” says Haywood. “Maybe we will shift to a three days in the office, two days at home model and there will be tectonic changes in terms of space requirements, but it definitely will not be the death of the office as predicted by some.”
The focus will increasingly be on the right type of office, in terms of location, quality of building, sustainability and ESG criteria.
“We’ll see occupiers being more discerning about the kind of space they take because their staff will be more discerning,” says Brown. “They will look at clean air, wellness certificates, amenities, location, environmental performance. Those who can’t meet those demands will lose out and those who can will do well.”
The current risk-off environment presents an opportunity for the brave or far-sighted to make some good investments, experts agree. “It’s a good time to buy well-located London offices, even with a bit of manageable risk, because they are good value compared to other European capitals,” says Brown.
“I would go for offices too,” says Haywood. “Best in class in London or in the regions. People might opt for less space in future, but they’ll want better space.”