INVESTMENT BULLETIN JUNE 2019
Institutional Investment in Property
The uncertainties surrounding the UK’s future relationship with its biggest and nearest trading partner continue to create strong headwinds for the economy. UK economic growth was estimated to have increased from 0.2% in Q4 2018 to 0.5% in Q1 as businesses grew inventories as part of their contingency planning for the original March Brexit deadline. Economic growth in the 12 months to March 2019 amounted to 1.8% compared to 1.4% in the 12-months to December 2018.
MSCI data indicates that All Property values contracted in Q2 for the third consecutive quarter. However, the rate of capital value reduction as measured by the MSCI Monthly index improved slightly from -0.8% in Q1 to -0.7% in Q7. The market decline is wholly attributable to yield impact of -0.6% as there was no Rental Value Growth to speak of at the All Property level. The initial yield on MSCI’s monthly index has increased from 5.02% in Q1 to 5.06% at the end of Q2.
Over the next two years, changes to Office for National Statistics (ONS) surveys that cover the financial sector will be necessary to improve the quality, coverage and granularity of UK financial statistics. This work entails wide-ranging redesign of the existing surveys that currently provide the Institutional investment data making continued production in its current form unviable. With effect from Q2 2019 we have therefore based this analysis on the Property Data database of investment transactions.
Domestic and Overseas investors together bought commercial property in Q2 2019 acquiring property assets worth £5.86bn and recording sales of £5.56bn. Net investment in Q2 of £292.4mn compared to net investment of £2.41bn in Q1. In the 12 months to June, net investment amounted to £6.28bn compared with net investment of £7.18bn in the 12 months to March and £5.87bn in the year to December 2018.
In the second quarter, UK institutions disinvested £653mn having previously disinvested £128mn in Q1. Total investment by UK institutions in the 12 months to June amounted to £402mn compared to £2.29bn in the 12 months to March and £2.25bn in the year to December 2018.
Net investment by Overseas Investors in Q2 amounted to £429mn compared to £2.84bn in Q1. Total investment by Overseas Investors in the 12 months to the end of June amounted to £5.79bn compared to £5.64bn in the 12 months ending March and £3.82bn in the year to December 2018.
Reits, listed and private property companies disinvested £1.02bn in Q2 compared to disinvestment of £871mn in Q1. Net disinvestment in the 12 months to the end of June amounted to £3.66bn compared with net disinvestment of £3.53bn in the 12 months ending March and disinvestment of £3.51bn in the year to December 2018.
Investment in Central London offices increased by 42% to £2.3bn in Q2 from £1.6bn in Q1 but there has nevertheless been a reduction in transactions of 21% in the rolling 12-months ending June 2019 compared to the 12-months ending June 2018. This key market segment made up 37% of all UK transactions in Q2 compared to the long run average of 29%.)
Net investment in Q2 decreased across most other market segments. Perhaps most surprising, was the 67% decline in industrial transactions from £18bn in Q1 to £596mn in Q2, given the strength of returns currently being produced by the sector. In a very thin market Shopping Centre transactions increased 345% from just £51mn in Q1 to £227mn in Q2 including the sale of Intu Derby for £186mn and the Pentagon Centre in Chatham for £35mn.
The largest deals of Q2 were concentrated in Docklands as the 25 Canada Square office building occupied by Citigroup was sold for £1.1bn and 30 South Colonnade occupied by Reuters was sold for £135mn. Other notable transactions of size in Q2 included a portfolio of Sainsburys supermarkets sold by British Land for £429mn and a portfolio of student accommodation in Southampton, Sheffield and Leeds for £134mn. The largest transaction in the Rest of the UK was the sale by L&G to Gulf Islamic Investments of adjoining Birmingham offices, Priory Court and the Lewis Building, for £149mn
Trends in real estate investment
Demand for alternatives is rising
The value of UK commercial investment acquisitions in the 12-months to the end of June 2019 fell 24% to £50.63 billion from £63.5 billion in the 12-months ending June 2018. June’s rolling 12-month total was the lowest since September 2013.
Central London remains the most popular segment for investors with 25% of market share but surprisingly industrial transactions only accounted for 14% of all transactions despite now representing 19% of the MSCI index and having been the best performing sector for each of the last years / quarters.
Over the last 5-years Central London office performance reached a peak in September 2014 when rolling 12m total returns of 27% were achieved. Performance slumped to near zero in early 2017 following the Brexit vote and has now stabilised at 4% year-on year as anxious investors await to see whether the UK’s new Prime Minister Johnson will follow through on his promises to deliver Brexit with or without a deal on 31st October.
Shares in Central London office specialist Reits, Derwent London and Great Portland Estates are currently trading at a price that reflects an 18% discount to net asset value (NAV). And even the share price of Shaftesbury, the Central London village retail Reit, is trading at an 18% discount to NAV. Such pricing indicates that equity investors expect the valuations of their portfolios to decline substantially in the medium term (see Chart 1).
Meanwhile, strong rental growth for industrial assets reflecting occupier demand and a shortage of new built space pushed the sector’s post Brexit vote total return performance up to 22% year-on-year by mid-2018. Although performance has fallen back in recent months total returns were running at 11% year-on year at the end of June capitalisation and its shares trade at a 15% premium to NAV (see Chart 1).
These numbers are supported by the valuations of Reits specialising in the industrial sector of the UK commercial real estate market. The shares of London Metric, a FTSE 250 company, with a portfolio of distribution assets, trade at a 19% premium to NAV. And, Segro is now the largest UK Reit by stock market capitalisation and it’s shares trade at a 15% premium to NAV (see Chart 1).Not at all surprising was the 50% collapse in shopping centre and retail warehouse transactions between June 2018 and June 2019. Retailer insolvencies, IVA’s and the growth of internet retailing have acted as a drag on retail real estate. In June year-on-year retail sector total returns fell to -4%.
The shares of Land Securities and British Land are trading at discounts to NAV of up to 40% (see Chart 1). Land Securities’ portfolio has a 42% exposure to Shopping Centres, retail Parks and Outlet Centres and a 48% exposure to Central London offices. British Land is very similar with a 51% exposure to Central London offices and a 45% retail exposure.
The shares of Intu and Hammerson who focus solely on retail and Shopping Centre assets. There biggest assets include the Metrocentre, Gateshead and Trafford Centre, Manchester, Bullring, Birmingham and Brent Cross, London. These shopping centre Reits are currently trading at a 70% discount to NAV, suggesting that investors think that shopping centre valuations will continue to soften (see Chart 1). Capital Values on the MSCI index have already declined 11% but clearly have further to fall.
Across the regions outside London the most popular destinations for capital in the last five years have been Manchester, Birmingham, Edinburgh and Glasgow. Investment in these locations peaked in 2018 just as the flow of money into London assets began to slow.
Manchester, Birmingham, Edinburgh and Glasgow are four of the five largest City economies outside London. The largest regional City economy is Leeds which the Office for National Statistics defines as including Barnsley, Bradford, Calderdale, Craven, Harrogate, Kirklees, Selby, Wakefield, York as well as Leeds itself (see Chart 2).
In the 5-years to end 2017, the latest year for which we have disaggregated ONS data, the fastest growing City economies were London, Birmingham, Cambridge, Edinburgh, Dundee and Glasgow which might be an argument for de-centralisation and devolution (see Chart 3).
The inclusion of Cambridge in this list is reasonably intuitive. Silicon Fen or the Cambridge Cluster is home to a large cluster of high-tech businesses focusing on software, electronics and biotechnology. Many of these businesses have connections with the University of Cambridge, and the area is now one of the most important technology centres in Europe. However, its tight real estate markets mean that investors have had difficulties in accessing investment opportunities to participate in the city’s growth.
The key trend, however, is the growth of investment in other or alternative real estate assets. In 2014 conventional commercial real estate represented by Shops, Shopping Centres, Retail Warehouses, Offices, Industrials and Business Parks accounted for 70% of all investment. In 2018 investment in Other real estate had grown from 30% to 40%. By the middle of 2019 Other assets represent 46% of all investment in the year to date. Private rented sector investment by Overseas Investors, UK institutions and Property Companies in residential has risen from 1% of all real estate investment in 2014 to 11% in 2019. The share performance of Reits investing in these alternative assets reflects this trend with the best performance coming from Unite Group investing in student accommodation and Primary Health Properties. These Reits are currently trading at a 30% premium to NAV.