The UK property market has shown remarkable resilience over the past two years. But against the backdrop of rising interest rates and the change in demand for commercial property, we see declining or at the very least stalling property values.
Traditional ‘bricks and mortar’ retailers are facing difficult times and the data suggests a growing dispersion in performance depending on store location. The competition from online retailers appears to be leading to higher vacancy rates and a reduction of floorspace and lower rents in the best case, and bankruptcy in the worst (as Maplin and ToysRUs demonstrate).
Office properties, particularly in London, are also under pressure. Underlying data shows net rents falling by as much as 20 per cent, rising vacancy rates and a high volume of un-let space currently under construction in the capital.
But one bright spot comes from the industrial sector. Following a near continuous decline in industrial rents over the past 20 years, rents hit an inflection point at the start of 2014 and are up 19 per cent since. Interestingly, despite the pick-up in activity, there does not seem to be a rise in new development, resulting in an overall reduction of available space.
The outlook for residential is a bit starker. With UK rates set to rise (possibly five x 0.25 per cent by 2021), there are some estimates that house prices could fall by 15 per cent by the end of 2021, matching the 14 per cent drop in residential values between 2008-09.
A 15 per cent decline in UK residential property prices suggests the house price-to-income ratio retreats back towards its 30-plus year historic average. London might face a deeper decline of 19 per cent, exerting pressure on the buy-to-let market and forcing sales and reducing rents for tenants.
Only a better than expected outcome of Brexit and a more vibrant UK economy would make us change our outlook. In such a case, increased demand for the UK’s traditionally scarce property supply would counter the higher burden of the cost of finance.
Thoughts on perception of risk
Events that increase uncertainty about the likely path of profits are bad news for any company’s share price, as President Trump’s recent tariffs announcement and Amazon tweets have proved.
Markets can be influenced by an incredibly large number of related but constantly shifting factors and knock-on effects. It’s that creation of new paths and possibilities that can destabilise markets through increasing uncertainty.
If the likelihood of extreme outcomes rises, investors look to insure against the bad ones. Some investors buy options to sell their assets at pre-set prices, an explicit insurance contract.
As a whole, the market builds in an implicit insurance. That insurance is the risk premium; the extra expected payout an investor estimates they need to make it worthwhile to hold a risky asset (compared with a non-risky asset like a bank deposit or short-term government bond). Because an investor needs a greater return in order to take the risk, the share price they’ll pay to buy some more of the company goes down, and the company’s valuation falls.
What can happen in times of prolonged uncertainty is the investor is shaken from their complacency and starts to feel they’ve taken on more risk than they really wanted. When the environment changes, they’re left having to decide while feeling uncomfortable and possibly fearful. (As an aside, this is why clients are asked to review their risks at least annually, hopefully when market moves aren’t influencing their perceptions of risk).
Of course, the main point of long-term investing is to get paid a diverse portfolio of risk premia on a pretty constant basis. What matters for each investor is getting the long-term holdings aligned with their risk appetite.
A useful working definition of long-term is “not needing the money for a number of years”. If one’s savings aren’t needed in the nearer-term, then history shows the best strategy is to get the asset allocation aligned to the risk appetite and then leave it that way through thick and thin.