17th May 2016
Rowan Dartington Signature’s Guy Stephens looks at concerns about the current commercial property market
The last week has seen some interesting developments in the commercial property landscape which suggest that investor demand is not quite what it was.
We turned a little more cautious earlier this year and discussed the issue at our asset allocation meeting some while ago. The observation was purely based on the ‘bricks to clicks’ phenomenon which has seen various established retail names rationalise their estate of property outlets. Examples of these have been B&Q (Kingfisher), the food retailers generally (apart from the discounters), Argos (following its acquisition by Sainsbury) and now BHS and Austin Reed (both in administration).
This doesn’t mean that commercial property as an investment asset class has had its day. It simply reminds us, in common with all property investing, that location and quality of tenant is paramount and certain parts of the retail sector are vulnerable to cannibalisation from on-line shopping. Warehouses, industrial Units, office and destination retail parks are still buoyant and the outlook is positive.
However, there is something else going on which caused Henderson Global Investors to move its £4bn UK Property Fund to a ‘bid’ price from the previous ‘offer’ price. This is a 5% swing and is a sign that they are experiencing redemptions to such a degree that they need to protect longer term investors in the fund and try to dissuade investors from redeeming. We spotted this immediately, discussed it and decided to watch the situation closely as we are heavily exposed to the sector and, similar to many investors, have enjoyed good returns over the last two years as a proxy for the less attractive fixed interest market. The latter has not been as weak as many had expected because interest rates have not risen but using commercial property as an alternative has not been costly as returns have been the strong. The IPD (International Property Databank) Index has returned 30% over the last 2 years whilst Gilts have returned 17% (interestingly Global Equities have also returned 17%).
As last week wore on, Henderson were followed by M&G and Standard Life who all declared an increase in redemptions. This caused us to get rather more analytical about the developing issue as clearly there are changes afoot. Our conclusions have settled on the evolving nervousness around Brexit rather than a fundamental shift in the outlook for the sector. Commercial property is a cyclical sector but it tends to move in long, drawn out, cycles and is correlated to economic growth as this is what drives demand. Investors are withdrawing from the sector, not in anticipation of imminent recession, but more as trepidation sets in ahead of Brexit.
Whilst this is a concern, as the outcome of this is impossible to forecast, we know that investment and infrastructure projects are being put on hold ahead of the vote. This is only to be expected because who would want to commit to a longer term construction project when the economic outlook could change dramatically if we choose to leave the EU. In addition, there may be voids in prime office locations in London from businesses engaged in financial services or at the very least, investors will become cautious of tenant demand should we choose to exit. No matter whether you believe the stay or leave camps, there will be uncertainty for quite some time if we choose to leave and that will delay further investment. Locking in gains of 30% over the last 2 years is probably quite attractive for some and especially overseas investors who can then hedge their exposure to sterling should it weaken dramatically.
This is short term tactical positioning whereas we invest in property for the long term attractions. Whilst economic growth is robust and well-supported in the UK, tenant demand is robust and voids stable, we see no reason to rush for the door. Even if we were to do that, we have to invest the proceeds and that leaves us the fixed interest market or cash, neither of which are attractive and provide limited income return.
So, for now, we are sitting tight but it is yet another illustration of what could well happen to this asset class if we vote to leave the EU. The reality is unlikely to be anything as bad as investors may fear but trepidation is creeping in and this will only intensify as the voting day approaches. A good time to have cash available as certain areas could become quite mispriced and that provides longer term opportunities.