Guy Barnard, Manager of the Henderson Pan European Property Equities Strategy and Co-Head of Global Property Equities, responds to questions on the upcoming UK referendum to leave or remain within the EU. Uncertainty in the run up to the referendum is impacting investor demand for UK property but the income characteristics of the sector should remain attractive regardless of the outcome.
Q: How is uncertainty in the run up to the EU referendum currently affecting property markets?
In the direct property market we have seen a substantial slowdown in the pace of investment activity. According to commercial property agent Lambert Smith Hampton, total UK commercial property volumes fell by 27% to £11.7bn in the first quarter of 2016. Central London offices, where the risk of the UK leaving the EU (‘Brexit)’ is considered the greatest, saw transaction volumes fall to £2.2bn compared to £4.6bn a year earlier. It is however difficult to disaggregate the impact of ‘Brexit’ from wider capital market uncertainty in Q1, and in a market that was already expected to slow from the very strong volumes in recent years. But clearly investment decisions are being delayed and we expect this hiatus to continue in the run up to the poll.
Conversely in the occupier market, property specialist CBRE reported that year-to-date office take up in central London had been 3.1mn sq ft versus a ten-year average of 3.2mn sq ft, and that a further 3mn sq ft is under offer into Q2 2016. While this data is backward-looking, it does suggest that business decisions are still being made despite the uncertainty.
Within the listed property market, since the start of the year UK property stocks have underperformed both wider UK equities and global property peers. London-focused stocks have lagged within the UK. As a result, many companies are trading at valuations not seen since the financial crisis as investors have reduced their allocations to the sector.
Q: What key risks would a ‘leave’ vote imply for European property equities?
The key risk we see is a further undermining of investor confidence and consequently delays in business and investment decisions. Short term, we would expect investment markets to remain weak and prices are likely to decline as risk premiums rise. The longer-term economic impact of ‘Brexit’ is harder to forecast, but UK occupier markets would suffer in the short term from a reduction in foreign business investment.
Stock markets are forward looking and we believe a high-level of ‘Brexit’ risk has already been priced-in. We would, however, expect more market volatility in the case of a vote to leave.
The knock-on effect on the rest of Europe is also likely to be significant, particularly with key elections in the year ahead; political risk will be a key factor for investors.
Q: Which areas of the property market would be impacted the most?
The London office market is likely to be most affected by short-term uncertainty caused by ‘Brexit’. Demand from financial and multinational occupiers will weaken as they decide how this will affect their businesses going forward. We would therefore expect to see rents soften.
Q: How have you repositioned your portfolios in anticipation of a ‘Brexit’?
We have significantly reduced exposure to the UK over the last year. However, this was less to do with ‘Brexit’ risk. It was more a reflection of higher valuations and our expectations of slower growth from UK commercial property this year and in coming years following several years of very strong performance.
Within the UK property market we have increasingly focused on structural growth (of a sector as a whole), rather than cyclical areas (that are more affected by changes in the business cycle). This includes self-storage, student accommodation and residential land outside London.
Although their investment decisions stacked up in isolation, we made two portfolio additions taking into account ‘Brexit’ uncertainty: Green REIT (Dublin offices) and Hansteen (UK and continental industrials and a beneficiary of weaker sterling).
Q: Do you see any opportunities should the UK exit the EU?
We would expect further monetary easing by the Bank of England. This will reinforce the case for income-producing sectors such as property, as long as income streams are robust (i.e. long-dated rental contracts). A weaker sterling could also attract additional international capital to UK property, as it did post the global financial crisis.
On the flipside, there may be greater incremental demand in other parts of Europe, e.g. office space in Frankfurt, Paris or Dublin, but we are sceptical of a mass move of jobs from London to other European countries.
Q: What’s your outlook for the remainder of the year?
Besides the risks posed by the EU referendum in the UK, we continue to believe that European property equities will perform well given the sector’s steady income streams and attractive and growing dividend yields. Valuations are looking increasingly attractive, which, coupled with attractive assets and strong balance sheets means we are confident the companies we invest in remain well-placed to deliver good returns to investors.