As many investors leave the commercial property sector following Brexit, is residential property now the solution for them to turn to?
It’s been an investment favourite for years, but investors are starting to fall out of love with commercial property funds.
Assets from offices to shops and industrial buildings have long been popular with institutions and large-scale investors for generations. Open-ended commercial funds, which enable investors to withdraw their money at any time, rose from £13 billion to £28 billion in the 10 years between 2006 and 2016.
But things are changing.
Transaction volumes are slowing and this year has so far been underlined by the level of outflows from the sector rather than the reverse. The dampening sentiment was particularly marked ahead of the EU referendum, with further withdrawals following the UK’s vote for Brexit.
So why is commercial property losing its appeal? And can residential property now be the strong investment alternative large-scale and institutional investors are searching for?
Immediate uncertainty causing knee jerk reactions?
£1.4 billion was taken out of commercial property funds in June. It was enough to prompt a number of the largest funds to temporarily halt trading.
Following Brexit, many speculators were making knee jerk reactions, basing their decisions on sensationalised news coverage. The process of leaving the EU will take the UK two years, so in the short term, nothing has actually changed.
But those with money in commercial funds have concerns over what the decision will mean in the long term, in particular those with assets in London and the City. Will fewer European businesses look to open offices in the UK’s financial centre? Will some look to relocate to cities within the EU?
The truth is that sales of commercial property have been sliding since the back end of 2015. Couple that with the immediate uncertainty and the projected fall in the value of commercial assets, and it’s initiated an acceleration in the waning interest.
However, as the Financial Times points out, “there are lots of good reasons to remain invested in property, as rents continue to offer good income compared to other asset classes”. Strong yield growth is one of property’s strongest investment qualities, along with long-term appreciation. When the Bank of England cut interest rates to 0.25% on August 4th, the strength of property yields became even more significant.
And property undoubtedly still remains one of the strongest investments in a post-Brexit UK. But while the immediate uncertainty surrounding large organisations and the business world is seemingly prompting many institutions to turn their back on commercial property, there is another real estate sector that’s gained increased investor attention following the EU referendum. A sector that currently has a huge opportunity for institutional investment.
Residential property can deliver in the short and mid-term
The UK is currently undergoing a residential property revolution.
Homeownership levels are falling, while the UK’s private rented sector (PRS) has reached record size. A combination of high ownership costs and changing generational attitudes towards owning one’s home means that Britain is fast turning into a nation of renters.
But while the demand for rental accommodation has increased, the supply of it has not. In cities such as Manchester, which has one of the fastest growing populations and one of the highest proportion of young workers, the demographic that chooses to rent the most, there is a demand to supply imbalance of rental accommodation of 4:1.
None of these fundamentals have changed since Brexit. Rising yields and strong future growth prospects have even prompted more investors to add residential assets since June 23rd during a new currency window of opportunity.
In fact, it’s also expected that the need for PRS property will be further underlined following Brexit. If, during the immediate period of uncertainty, lending becomes restricted, fewer people will be able to acquire the finance to move onto the property ladder. This will put increasing pressure on the PRS at a time when it’s already close to full capacity.
What’s more, it will be those investors that act now, while the pound has created a window of opportunity for anyone dealing in international currencies, which stand to gain the most in long-term growth once the uncertainty is lifted.
There is also an opportunity to invest in a product that will change the future of rented living in the UK. While some investors may be searching for a new alternative to commercial real estate, those living in the PRS are searching for an institutionally driven product to transform the rental market. One that will become the 21st century solution for Britain’s growing number of long-term renters.
Build-to-rent: An investment in the future
When the UK government announced the increased rates of stamp duty for second home purchases, which came into effect on April 1st, it was an acceptance. An acceptance that buy-to-let is broken.
No longer can the traditional buy-to-let home, one initially intended to be lived in by owner-occupier families, adequately accommodate the long-term renter. Young workers want the best amenities, the best quality and, crucially, a professional level of service and management.
Knight Frank estimates that the build-to-rent sector, purpose-built rental accommodation, will be worth £50 billion by 2020. While in the commercial sector, values are expected to now drop by as much as 10% at a time when liquidity is scarce.
Build-to-rent provides homes with the quality and service tenants want, and the regulation the UK government wants.
More than 60,000 build-to-rent units are now in the pipeline, according to data from the British Property Federation.