INVESTMENT BULLETIN DECEMBER 2018
Institutional Investment in Property
Economic output increased by 0.4% in Q3. Year on year growth picked up to 1.5% but remains relatively subdued compared to historical standards.
Services, construction and manufacturing all made positive contributions to Q3 growth. Household consumption grew but business investment decreased for the third consecutive quarter.
MSCI data indicates that All Property contracted in Q4 having risen for the previous 24 quarters in succession. The rate of capital value growth as measured by the MSCI Monthly index decreased from 0.4% in Q3 to -0.2% in Q4. The market decline is attributed to Rental Value Growth of -0.1% without any appreciable yield impact. The initial yield on MSCI’s monthly index is 4.94%.
Institutional investors bought commercial property in Q3 2018 acquiring property assets worth £1.65bn and recording sales of £1.42bn. Net investment in Q3 of £229mn compared to net investment of £599mn in Q2. In the 12 months to September, net disinvestment by institutions amounted to £827mn compared with net disinvestment of £481mn in the 12 months to June and net disinvestment of £1.07bn in the year to September 2017.
In the third quarter, pension funds disinvested £95mn compared to a net investment of £58mn in Q2. Total investment by pension funds in the 12 months to September amounted to £63mn compared to £465mn in the 12 months to June and £760mn in the year to September 2017. Life companies were net buyers of property for the third consecutive quarter. Net investment in Q3 amounted to £247mn compared to £487mn in Q2. Total disinvestment in the 12 months to the end of September amounted to £873mn compared to disinvestment of £587mn in the 12 months ending June and net disinvestment of £17mn in the year to September 2017. Property Unit Trusts invested 222mn in Q3 compared to investment of £12mn in Q2. Net investment in the 12 months to the end of September amounted to £91mn compared with net disinvestment of £281mn in the 12 months ending June and disinvestment of £1.98bn in the year to September 2017 (National Statistics, 2018).
In Q4 2018 total investment in UK commercial property by all domestic and overseas investors is estimated to have decreased by 31% to £11.1bn from £16.1bn in Q3.
Investment in Central London offices decreased by 26% to £2.9bn in Q4 from £4.5bn in Q3. This key market segment made up 26% of all UK transactions in Q3 compared to the long run average of 30%. Net investment in Q4 also decreased across all other market segments compared to Q3 with the exception of Shopping Centres. (Property Data, 2018)
Investment by UK institutions and property companies decreased by 35% in Q4 to £5.4bn from £8.4bn in Q3. Money into UK commercial property from overseas investors decreased by 26% in Q4 to £5.6bn from £7.6bn in Q3. Overseas investors share of the UK investment market in Q4 amounted to 51%.
(Property Data, 2018)
The largest deal of Q4 was the £1.58bn purchase of Battersea Power Station by the Malaysian Employees pension fund and the Malaysian sovereign wealth fund. The asset included six floors in the Central Boiler House let to Apple as its London HQ and 100 retail and food units
Total institutional investment in Q3 was negative for the third consecutive quarter. Net disinvestment amounted to £11.7bn compared to net disinvestment in Q2 of £3.5bn. Investors sold Short Term assets and continued to limit their exposure to risky assets by selling UK Equities and Overseas Securities and increased their holdings of UK Gilts. (National Statistics, 2018)
Reflections on 2018 & the outlook for 2019
Investment in UK Property (£mn) Q3 2018
Source: National Statistics
Net Institutional Investment by asset type (£bn)
Source: National Statistics
Net Institutional Investment in Property (£bn)
Source: National Statistics
Investment by sector (£bn)
Source: Property Data
Property investors by type (£bn)
Source: Property Data
Brexit uncertainty dominated in 2018 and is likely to shape UK markets again in 2019.
Domestic politics continued to provide the biggest downside risk facing UK investment markets in 2018 as Brexit dominated the news. Indeed the whole sorry saga drags on with the likelihood of providing an outcome that is unsatisfactory to both Leavers and Remainers, In 2019 UK markets will once again be haunted by uncertainty. Will the UK join Mauritania as only the second country seeking to trade with the rest of the world solely on WTO terms; continue trading with it’s closest neighbours as full members of the EU; or perhaps HMG will actually conclude the easiest trade deal in history with the remaining 27 EU states.
Kristalina Georgieva, Chief Executive Officer at the World Bank said, “At the beginning of 2018 the global economy was firing on all cylinders, but it lost speed during the year and the ride could get even bumpier in the year ahead”.
The World Bank estimates that global economic growth in 2018 declined slightly to 3.0% in 2018 from 3.1% in 2017. International trade and manufacturing activity have softened, trade tensions have been elevated as President Trump continues to pursue his America First agenda, and advanced economies and emerging markets have experienced substantial financial market turbulence.
The World Bank also forecasts that global economic growth will decline further to 2.9% in 2019. Growth in advanced economies is expected to moderate to 2.0% in 2019 and 1.6% in 2020. Growth in emerging market and developing economies is projected to stabilize at 4.2% in 2018 and 2019, as weaker international trade and investment have lead to a deceleration in commodity markets.
President Trump’s 2017 tax cuts seem to have had a limited but positive impact on economic growth in the USA which is estimated to have grown from 2.2% in 2017 to 2.9% in 2018. But the overall Strength of the economy has caused the US Federal Reserve to announce in December, a ninth consecutive rise in interest rates since late 2015, from 2.25% to 2.5%. Responding to Trump’s trade wars and rising interest rates the Dow Jones declined 5.6%; the S&P500 was down 6.2% and the NASDAQ fell 4%, making 2018 the worst year for stock markets since 2008.
In the UK, the economy grew by a lacklustre 1.5% in the year to November 2018 and the latest OBR forecasts indicate that this could be as good as it gets for the next 5-years. Nevertheless, the MPC noted that inflation was above its target, the squeeze on pay was starting to ease and employment was at a record high, and opted to raise interest rates to 0.75%. MPC guidance indicated that rates would rise further but on a limited and gradual basis. The forecasts in February’s Inflation Report imply that rates could be 1.5% by the end of 2021. This seemed to settle currency markets and the pound only fell 1.5% over the year despite the Government’s postponement of the promised meaningful vote on Brexit.
Taking a lead from the USA markets, the FTSE 100 index fell 12.5% in 2018 and European Bourses also followed this trend. Germany’s Dax declined 18% over the course of 2018, and the Dax Tech index slipped 3%. France’s CAC fell 11% and Italy’s FTSE MIB was down 17%. In the Far East, China’s Shanghai Composite shrank 25% and the Nikkei fell 12%.
Factor investing has gained increasing traction in the last few years along with the growth of ETFs. MSCI indicates that a factor can be thought of as any characteristic relating to a group of securities that is important in explaining their return and risk. They identify six factors for equity investing that have historically provided a return premium; namely, Value, Low Size, Low Volatility, High Yield, Quality and Momentum. A range of ETFs now offers investors exposure to each of these factors for the USA, European and World markets. Interestingly some of these factors have offered investors some protection from the worldwide fall in markets noted above (see Table).
Total Return by factor
A year ago the headline performers were crypto currencies and in particular Bitcoin. The price of Bitcoin surged by more than 900% in 2017 drawing comparisons with 17th century tulip mania and the more contemporary dotcom bubble. However, in 2018 the price of Bitcoin fell 72% as US regulators refused to approve Bitcoin ETFs and cryptocurrency exchanges suffered from hacks.
At the start of 2018 IPF Consensus forecasts, were for commercial property to provide total returns of 4.6% in 2018. However, rental growth of 0.7% and yield compression of 14 bps resulted in All Property total returns of 7.5% in 2018 – an outcome that was more than respectable given the losses in mainstream markets.
The best performing segments of the UK commercial property market in 2018 were once again London, South East and Rest of UK industrials (see Chart). And, Segro valued at £6.39bn took over from Land Securuites with a market capitalization of £6.36bn as the largest listed property company. Segro’s portfolio of industrial and logistic assets valued at £8.3bn are clearly rated more highly by investors than Land Securities £13.65bn of Shopping Centres and Central London offices.
Retail property experienced another torrid year in 2018 as Amazon and other on-line retailers continue to disrupt high street businesses. The capital value of Shopping Centres declined 9%, Rest of UK shops fell 7% and Retail Warehouses were down 6%.
The retailer Next is vocal about the rent drops it is securing from landlords. Among 19 stores where leases were renewed in 2017-18, Next said net rents, taking into account capital contributions, were down 28 per cent. In 2018-19 Next anticipates it will secure rent drops of 27 per cent, not including the 10 shops it will close altogether.
The long list of high street failures in 2018, included House of Fraser, Evans Cycles, Maplin and Poundworld, while other chains including Mothercare and Carpetright, closed underperforming stores. Marks and Spencers and Debenhams have already announced plans to close stores in the coming year.
A recent RICS Valuation Notification acknowledged that the retail property market was suffering structural change driven by behavioural change in shopping habits that might not be fully reflected in recent market activity. Valuers are therefore advised to reference the widest range of evidence available including relevant market analysis and commentary, and be aware of the potential for significant changes in value.
Property performance by segment in 2018
Source: MSCI & APR
Subdued expectations for equities and bonds have encouraged institutional investors to increase their property holdings in 2019. At least €72.4bn of new capital is expected to flow into real estate globally this year, according to a survey of 144 institutional investors and 10 fund of fund managers.
European investors intend to increase their real estate exposure from 5.2% to 5.9% and investors in North America with 8.5% in real estate are targeting an allocation of 10.0%.
Unsurprisingly Brexit has affected investors’ thinking. Germany topped the list of preferred investment locations for 2019 after being selected by two-thirds of respondents. The UK, which ranked first in 2018, did well to hold on to second spot, while France was the third most-favoured location. It is, however, unlikely that much of this new capital will be committed to retail real estate or to the UK before Brexit deadline day on 29th March.