When will the tide turn on UK commercial property?

Transcription

1 When will the tide turn on UK commercial property? MIPIM March 2018 $ $ $ When will the tide turn on commercial property? MIPIM 2018 Colliers International 1

2 Contents Page 4 When will the tide turn on commercial property? Page 6 A financial pivot point Page 9 Transition to the new normal and global capital Page 10 The new normal Page 12 The outlook for UK property Page 14 The long-term outlook for global property 2 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 3

3 When will the tide turn on UK commercial property? This depends, of course, on what you mean by the tide. THE ECONOMY - ANNUALISED GDP GROWTH 2017 TO 2022 World Developing Economies BRICs Advanced Economies United Kingdom Eurozone United States 1% 2% 3% 4% 6% Source: Oxford Economics The global economy has been going through a synchronised expansionary phase which is set to continue over the next five years. CAPITAL AVAILABILITY - GLOBAL FUND ASSETS UNDER MANAGEMENT The Economy? If by tide, you mean the economy, then the answer is: not anytime soon. The global economy in general is going through an expansionary phase. Forecasts show that this is likely to continue for some time. Given the ongoing impacts of quantitative easing and the new phenomenal fiscal stimulus that arithmetic shows that a 1% increase equals $700 billion, or roughly half of the $1.4tn annual property investment market. The allocation tide may not yet be turning, but the rise may be slowing. The Financial Environment? trilion Institutional Private Equity Sovereign Wealth Source: IPE (Top 400 instituional funds), PERE, SWFI Global capital remains at staggering heights, partly the result of increased asset value, partly the result of demographic pressure. is being undertaken in the US, the forecasts may understate the If by tide, however, you mean a sea change in the financial eventual outcome. World growth is expected to average 2.8% pa over the next five years, with the BRICs economies averaging environment, then recent events suggest an emphatic: probably ; and if you think this environment can change and not FUND ALLOCATION TO PROPERTY - % OF AUM & VALUE 5.1% pa and the advanced economies at 1.8% pa. impact global property investment, think again! Capital Availability? If by tide, you mean the availability of global capital to support property investment, then the answer is also: not anytime soon. Global capital remains at staggering heights, partly the result of increased asset values, but also the result of demographically driven net inflows of new funds. In 2017, assets under management by the top 400 global institutions topped the $70tn mark (IPE). Global demographics data shows that global retirees will continue to contribute to a global savings glut for another generation and certainly to the end of the next decade. Fund allocations to property? If by tide, you mean fund allocations to commercial property, Global interest rates and bond yields may have reached the end of a 36-year bull market that has seen phenomenal yield compression. Real ten-year yield percentages have been negative in several countries. These low yields have supported asset prices across all asset classes, including equities and real estate, through its impact on fund investment allocations. Likewise, the cost of debt has been driven to very low levels. Consequently, real estate yields have been driven down to extremely low levels globally. Given the recent financial market movements, the question is, perhaps, not so much when will the financial tide turn, but what will the new normal look like, when will it arrive and what will the transition be like? As far as the tides turning on commercial property, the question has to do with whether a long period of yield 10.3% 10.1% 9.9% 9.6% 9.3% $5.3tn $5.4tn f Source: Hodes Weill & Associates, AUM = assets under management REAL 10-YEAR BOND YIELDS 1 UK $6.2tn EZ US Japan UK Property $7.2tn $7.5tn Capital fund allocations to property continue to increase in percent terms and absolute terms. Increasingly, it looks as though the 36-year bull market in global bonds has run its course. then the answer is a more modest: not yet. Allocations have risen from 8.9% in 2013 to 10.1% in 2017 and are forecast to reach 10.3% in 2018 (Hodes Weill & Associates). Simple compression has come to an end given the shift in the financial environment Source: Oxford Economics (January 2018). Real yields = nominal yields - CPI inflation. 4 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 5

4 A financial pivot point The US contribution. Many historical turning points in the global financial cycle are related to steps, or missteps, in US regulatory policy, whether fiscal, monetary or prudential. The US economy same period, the benchmark 10-year Treasury yield rose from a record low of 1. in mid-2016 to 2.4% by the end of In the first months of 2018, the yield has risen by a further 50 This had the intended effect of lowering bond yields globally, staving off deflation and providing an economic stimulus. The great unwinding is now beginning outside the US: accounts for almost 3 of global gross domestic product and, despite the rise of China and the consolidation of the Eurozone, the US dollar remains the international reserve currency. Hence, events in the US continue to define the global economic and financial operating environment. In 2015, the US was the first advanced post-great Recession economy to raise interest rates. Nevertheless, if a definitive turning point is to be discerned, it should be focussed on 2017, when the US Federal Reserve raised interest rates three times and announced three further increases for 2018 (the official rate bps to 2.9%, driven by expectations of stronger US growth and inflation, higher base rates, new and substantial unfunded fiscal stimuli and major tax reforms. The global contribution. The US may have started the ball rolling, but central banks in other advanced economies have joined in normalising monetary policy by raising base rates, winding down QE and removing other emergency measures implemented to prevent a deep recession from progressing into a sustained depression. Collectively these emergency measures resulted in the injection of over $10tn into national banking»» The European Central Bank tapered bond-buying from 60bn to 30bn per month in January The 2.3tn bond-buying programme is scheduled to end in September 2018, with the first rate rises anticipated in mid-2019.»» The Bank of Japan began reducing its massive QE programme (equivalent to 8 of GDP) through unannounced reductions in bond purchases, described as stealth tapering. Inflation remains low and rate hikes unlikely. 450bn may rise to 2% for the first time in 10 years). Furthermore, the US was also the first country to begin unwinding QE by limiting reinvestment of coupon payments in late October Over this systems. This amounts to almost half of US annual GDP, or around 1 of global GDP.»» The Bank of England is following its own path given Brexit uncertainty. No plans for QE reductions have been announced, but the Term Funding Scheme closed on 28 $4.2tn February Commercial bank lending rates are likely to rise. Official rate hikes are expected, but remain linked to Brexit, sterling and business confidence. CUMULATIVE QE ASSET PURCHASES $trillions UK ECB US 1 JPN ¹US data includes MBS holdings Sources: Bank of England, ECB, FRB (NY), Bank of Japan In comparison to what is being done in the US, these initial policy adjustments have been modest, so far. Given the market reaction to US moves, removing the vast stimulus will be done very gradually, especially in markets vulnerable to political instability (especially the UK & Eurozone). The transition period will be measured in years and will most likely move in line with the natural expiration rate of the QE bonds that are held, rather than any aggressive programme to begin selling the accumulated stock of bonds. In this respect, the financial tide may have turned, but it looks more like a gradual medium-term transition to a new normal rather than a rapid return to the previous financial regime. 2.3tn 418tn 6 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 7

5 $ Transition to the new normal and global capital A gradual transition to a new normal will require global capital sufficient to support such a transition. The evidence suggests that global capital is sufficient. In 2018, an anticipated $2.2tn of US government and corporate bond issuance necessary to support fiscal policies and cover corporate refinance of maturing bonds is matched by an estimated $2tn in US domestic corporate cash reserves as well as another $1.5tn in US corporate offshore cash holdings. As bond yields rise, the opportunity costs of holding cash will become high and many dormant investors will re-enter the market. However, recent research from Blackrock (January 2018) shows that despite higher bond yields, global institutions plan to reduce exposure to equities and expand exposure to real assets commodities, precious metals, real estate - rather than increase exposure to bonds and fixed income. Appetite for fixed income is linked more to private credit investment than to core products such as US Treasury bonds. This suggests that US Treasury yields must rise further to attract investors. In comparison to the US, European and UK government financing requirements are modest. The ECB, despite tapering, is still buying bonds and, like the US, there is a large EMEA corporate cash reserve amounting to $1.1tn (Moody s July 2017 estimate). Given that European and UK 10-year bond yields are still 1. to 2% lower than US 10-year bonds, especially when ECB QE purchases are phased out in September, European and UK yields will also need to rise to attract investors. Given the role that global bond rates play in providing pricing benchmarks for commercial property, their movement is monitored closely by many property investors. The question is less about whether bonds will rise, but rather how far they will rise, and when? ALLOCATION BALANCE FOR NET CHANGE Global Continental Europe US/Canada Equities Fixed Income Hedge Funds Private Equity Real Estate Real Assets Cash Source: Blackrock, 2018 Global Insitutional Rebalancing Survey, Jan 18 8 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 9

6 The new normal While it looks as though the 36-year bull market in global bonds may have run its course, there is little evidence to suggest that yields will return to previous high levels. Bond yields will rise over the medium-term, but will arrive at a more benign level for a variety of reasons, reflecting several enduring factors that drove the long-term bull market in the first place (Oxford Economics, 2016). Foremost among these is demographic aging and the savings glut as detailed above. According to academic studies, this factor alone may be responsible for around 125 bps of yield compression. Aging has meant falling economic growth potential as well as increased savings. Likewise, US data suggests that QE is responsible for another 100 bps of compression. A variety of other factors have also depressed bond yields, as detailed in the table below. Factors Description ¹Long term effect on rates Demographic aging Reduced labour pool lowering economic growth potential. Increased savings ( savings glut ) & demand for interest 100 bps Of direct relevance to UK property is the shortage of safe assets globally. While this shortage has driven bond yields lower, it has also driven yields on prime commercial real estate assets in Central London and other gateway cities lower through direct investment given their appeal as wealth preservation assets. QE and lack of safe assets explain why 10-year bond rates fell so low and why prime property yields are at record lows across prime markets in Europe and the UK. Bond yield and base rate forecasts. Given these enduring long-term factors and, especially, the necessity for a gradual, possibly a decade long liquidation of QE bond holdings, the new normal is scheduled to arrive in the US when bond yields peak at 3. in 2022, in the UK when bond yields peak at 4% in 2023 and in the Eurozone only by 2030 when bond yields peak at 3.8%. Given the enduring factors, bond yields will rise more slowly than general economic conditions might otherwise seem to warrant. Furthermore, the risks to the forecasts are to the downside. Base rates follow a similar pattern as bonds and, like bonds, will peak at lower levels than previously. But, like bonds, the UK in particular will peak at a higher level (+50 bps) than both the Eurozone and the US, reflecting stronger anticipated economic growth over the forecast horizon. For global property, the relatively benign environment suggests that any softening in pricing and outward yield shift will be gradual and more modest. Lower volatility looks increasingly like the long-term norm for property pricing. Quantitative easing Impact primarily on long-term bond rates 100 bps Slow productivity growth Undermining economic growth potential 80 bps Rising debt margins Shortage of safe assets Capital goods price falls Base rates compensate for increased borrowing costs Lack of safe haven assets globally Impact of globalisation and free trade 70 bps 50 bps 50 bps Income inequality Wealthy have higher savings rate 45 bps Fall in public investment Constrained budgets limit fiscal economic stimulus 20 bps PEAK TEN-YEAR BOND YIELDS (NOMINAL) 6% 4% 3% 2% 1% Average Forecast peak Downside % 4.7% 2.3% % US UK Source: Oxford Economics (February 2018, October 2016), Colliers International QE phase 1.7% EZ (DE) BASE RATES FORECASTS 6% 4% 3% 2% 1% Average Forecast peak Downside QE phase % % 1.8% 4.6% 0. US UK EZ (DE) Source: Oxford Economics base data (Feb 18 & Oct 16) as extrapolated by Colliers International 3.3% 2.4% 2.9% 0.1% 2.8% 1.6% ¹These numbers are indicative only, interpreted from OE s compilation of values from numerous studies. Source: Oxford Economics, Research Briefing 28 October When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 11

7 The outlook for UK property Headroom and a low volatility outlook. Lower volatility is also Sterling arbitrage remains supportive. Furthermore, UK a feature of UK property industry forecasts. The IPF consensus property is also supported by an ongoing currency arbitrage for the five years to 2022 shows that total returns will remain that is not likely to disappear until the terms of any political stable in mid-single digits at an annualised 4.8% pa rate. This settlement with the EU have become clear and are agreed. reflects very modest rental growth of 1.1% per annum and capital Sterling remains almost 10-1 down on its average level in the value growth of -0.1% per annum. Colliers International forecasts six months prior to the EU referendum. By various measures, are roughly in line with the industry consensus, but show greater sterling is understood to still be down by around 10-1 on details with All Property yields drifting by around 10 to 20 bps long-term international equilibrium value. For an overseas UK before moving in again by a similar amount. This may happen property investor who expects sterling to revert to its long term despite an outward movement in bond yields from around 1. value, this arbitrage works out to the equivalent of between 50 to to 3.8%. 100 bps in yield depending on your existing yield. IPF CONSENSUS FORECASTS Rental growth Capital value growth Total return 6% 4% 3% 2% 1% Source: IPF The IPF consensus shows that returns from 2018 to 2022 will remain stable in the mid-single digits at an annualised 4.8% rate. This apparent anomaly demonstrates the amount of headroom In short, the outlook for UK property remains strong, buoyed on that exists between All Property equivalent yields and the by many short and long-term factors. Increasingly, investors are 10-year gilt rate. The difference between Q4 17 MSCI/IPD All Property yield at 5.6% and the 10-year gilt at 1.3% remains very wide at 430 bps. Much of the anticipated rise in gilts will be absorbed within that wide margin. In the period 2001 to 2007, the yield gap averaged 240 bps, suggesting that gilts would need looking beyond London into the regional growth cities. Since the early 2000s, international investors have invested successfully across the UK and this familiarity has widened the investible UK universe. Coupled with regional political devolution, the UK looks set to benefit from further expansion of international investment Colliers International forecasts are roughly in line with the industry consensus, but show greater detail with 'All property' equivalent yields drifting out by 10-20bps before moving back to rise by almost 2% before any significant impact was likely. Quantitative easing has little impact. Interestingly, the figures suggest that UK property pricing was generally unaffected by the 100 bps of yield compression that might theoretically be attributed to UK quantitative easing. Hence, over the longer term, any unwinding of UK QE looks unlikely to have any flows. The Brexit negotiations may have caused some investors to pause and take stock, but the very recent evidence suggests that international occupier demand for space in Central London and the UK has accelerated, even in the absence of a clear Brexit agreement. in by a similar amount. Walter Boettcher Director Chief Economist ALL PROPERTY EQUIVALENT YIELD AND 10 YEAR GILT RATE disproportionate impact on UK property. Low yielding prime and institutional grade assets would seem to be in the line of fire, but the ongoing global demand for safe haven assets looks set to hold pricing firm, even in the lower yielding market segments. 6% 4% 3% 2% AP equivalent yield Ten-year gilt yield All property yields are forecast to drift out, before moving in again despite an outward movement in bond yields. 1% Source: Colliers International, Oxford Economics 12 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 13

8 The long-term outlook for global property In 2015, Colliers International published the paper How 10 to 15 years. This is not to say that the original property bull long will this bull market last? where we argued that many market will rumble on for a generation, but it is to say that the enduring trends would act to support commercial real estate sector looks to have reached a new level of maturity in the UK, and that going forward this asset class would be lower yielding with a wider range and geography of prime assets now elevated with limited volatility. In 2018, the trends continue to support to the status of safe haven investments. This may be part this view. Barring a new financial, economic or geopolitical of a global trend. Like all assets, safe haven property assets calamity, the long-term outlook looks stable, with the financial will continue to require careful management and investment, environment settling into a new normal over the next five to especially as the demand of occupiers (the ultimate source of 10 years that looks more benign than the pre-great Recession all value) increases in complexity in response to ever changing period. Much of this stability can be traced in various ways to a demographic pressure and the demands of new technology. demographic super-cycle that is set to last for at least another...the sector looks to have reached a new level of maturity in the UK with a wider range and geography of prime assets now elevated to the status of safe haven investments. COMPRISE OF 15,400 PROFESSIONALS MANAGING 2B (SQUARE FEET) REVENUE $2.7B (US DOLLARS) ESTABLISHED IN 69 COUNTRIES Mark Charlton Head of Research & Forecasting Contacts LEASE/SALE TRANSACTIONS 68,000 TRANSACTION VALUE $116B FOR MORE INFORMATION Walter Boettcher Director Chief Economist walter.boettcher@colliers.com Mark Charlton Head of Research & Forecasting mark.charlton@colliers.com This report gives information based primarily on Colliers International data, which may be helpful in anticipating trends in the property sector. However, no warranty is given as to the accuracy of, and no liability for negligence is accepted in relation to, the forecasts, figures or conclusions contained in this report and they must not be relied on for investment or any other purposes. This report does not constitute and must not be treated as investment or valuation advice or an offer to buy or sell property. Colliers International is the licensed trading name of Colliers International Property Advisers UK LLP (a limited liability partnership registered in England and Wales with registered number OC385143) and its subsidiary companies, the full list of which can be found on Our registered office is at 50 George Street, London W1U 7GA. This publication is the copyrighted property of Colliers International and/or its licensor(s) All rights reserved 14 When will the tide turn on commercial property? MIPIM 2018 Colliers International When will the tide turn on commercial property? MIPIM 2018 Colliers International 15

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