What a year 2016 was! Who would have thought last January that the UK would vote to leave the European Union, Donald Trump would win the US election and Leicester City would win the Premier League.

Allan Lockhart

What is even more surprising is that the markets liked these outcomes: the FTSE 100 and S&P 500 closed on 30 December at near all-time highs, even with the Italians voting ‘no’ to constitutional reform.

Unfortunately, the same cannot be said of the UK quoted real estate sector, which significantly underperformed relative to the FTSE 350 Index.

Indeed, 2016 was the worst year since 2007 and the third worst for 20 years. Conversely, global real estate performed well, delivering a total return of 8.1% compared with global equities at 9.9% and global bonds at 2.9%.

But as Amos Tversky, the renowned cognitive and mathematical psychologist, said: “He who sees the past as surprise-free is bound to have a future full of surprises.” So could the UK-quoted real estate sector surprise the markets with a bounce-back in 2017?

Outlook doesn’t look great for US real estate

According to EPRA, North American real estate delivered a total return of 11.4%, Asia 9.3% and Europe (excluding the UK) 5.1%. In stark contrast, the UK delivered a total return of -8.5% in spite of its economy performing well last year. Clearly Brexit meant Brexit for UK real estate.

Moreover, according to the new narrative of rising US bond yields, higher inflation and higher interest rates, particularly in the US, the outlook doesn’t look great for real estate without higher growth in the economy - or mixed at best.

Specialists on top

For the past three years, I have highlighted the performance of UK-quoted real estate companies with predominantly UK-focused portfolios and a market capitalisation in excess of £100m. With the exception of Secure Income REIT, whose total shareholder return (TSR) performance was outstanding at 30%, the TSR for the companies highlighted in the table ranged from 15% to -36%.

Only 14 companies delivered a positive capital return, although taking into account dividends declared, 21 companies did so. Even then, only one company actually beat the FTSE All-Share Index.

Once again, it is companies that are either specialists and/or income-focused that occupy the top positions in the league table.

Companies that are more London-focused and/or development-focused and have benefited from significant development profits in recent years have been hit hard by equity investors.

Listed real estate companies ranked by total shareholder return in 2016
 CompanyTSRApprox market cap (£m)
1Secure Income REIT30%717
2FTSE 10019% 
3FTSE All-Share17% 
4Tritax Big Box REIT15%1,542
5MedicX Fund13% 
6Picton Prop Income11% 
7Target Healthcare11%285
8SEGRO Plc11%3,803
9Regional REIT9%296
10Custodian REIT9%353
11Primary Health8%666
13S Life Inv Prop Trust7%329
14FTSE 2507% 
15F&C Comm Prop Trust6% 
16NewRiver REIT5%797
18UK Comm Prop Trust4% 
19Hansteen Holdings4%845
20F&C UK RE Inv3%236
21AEW UK REIT1%118
22Safestore Holdings1%730
24Schroder RE Inv Trust0%296
27Daejan Holdings-1%1,009
28ESP Empiric Student-1%531
29Mountview Estates-3%431
30A&J Mucklow Group-4%294
31UNITE Group-5%1,345
32Land Secs Group-6%8,429
34FTSE 350 Real Est-7% 
35Conygar Investment-9%112
36Capital & Regional-11%386
37Big Yellow Group-12%1,082
38Town Centre Secs-12%147
39Redefine Int-15%710
40Workspace Group-16%1,293
41CLS Holdings-16%623
42British Land-16%6,482
43Kennedy Wilson Eur-17%1,210
44Great Portland Est-18%2,299
46Derwent London-23%3,088
47St Modwen-25%674
48McKay Securities-31%163
49Capital & Counties-32%2,514
Where no Market Cap is supplied for non-index entries, no information was available. Companies listed in blue are REITs. Source: Bloomberg

But are the markets overstating the case for higher bond yields and interest rates? Research from the Bank of England shows that interest rates have been declining for 35 years. The main reason is the supply of savings far exceeding demand for investment, thus lowering interest rates as well as the cost of capital.

An ageing and more slowly growing population, income inequality and lower productivity are the main drivers for the savings glut and lower investment demand. These demographic trends are very likely to continue supporting lower demand for capital and thus lower interest rates for longer.

Attractive and secure return

Our basket of listed real estate companies currently returns a dividend yield of circa 3.6%, so in a world of excess capital I believe a sustainable income underpinned by recurring cash revenue streams from a diversified occupier base provides an attractive and secure return.

That leaves Brexit. Given the fall in the value of sterling, the effective price for UK real estate for international buyers is very attractive and perhaps this will support values, particularly for the London market. In addition, it is highly unlikely that the terms of the EU divorce will be apparent until well into 2018.

Many of the quoted real estate firms are well placed to face the challenges and likely volatility of 2017 given their high-quality management teams and conservative balance sheets, so perhaps the surprise of 2017 will be the outperformance of the UK-quoted real estate sector against the wider equity markets.

Allan Lockhart is property director at NewRiver REIT