While other asset classes have suffered, thanks to weak global demand and financial market volatility in recent years, UK real estate has enjoyed a great run.
The downside of this is some UK real estate is looking expensive compared with other repriced asset classes. At its worst, the FTSE 100 was down by 19% year on year in February and UK REITs were not immune.
In truth, UK real estate has been slowing for the past 18 months and investment volumes have fallen. Central London office and retail volumes hit a five-year quarterly low in the first quarter, with worse expected in Q2, following a UK referendum-induced hiatus.
However, we have expected a slowdown for some time. The UK has led the cycle in Europe and we, like others, have been switching from an aggressive strategy to a more defensive late-cycle approach.
Our emphasis is on super-prime, long-leased assets, strong covenants and sectors with non-business-cycle drivers. Whether the UK leaves or remains in the EU, our stance is unlikely to change. So if the UK ‘Bremains’ we will not become ‘risk-on’, even if volumes rebound.
The emphasis on defensive, long-term assets will lead us to selectively buy core offices with high-quality income. We expect volatility but with a long-term view and a tolerance for short-term volatility, assets such as Asticus, which we recently acquired for our AXA CoRE Europe Fund, are among the best sources of low-risk income available.
A develop-to-core strategy also takes a long-term view embodied by our commitment to developments such as 22 Bishopsgate, which represent a small proportion of our activity, but play an important role in a slowing market. Europe has seen little new office supply for years, but tenants still need grade-A space, and letting risk can be managed over the build time.
The same dynamics and strategy apply to logistics, so we will continue to explore speculative and build-to-suit options in the UK, while improving the defensiveness of our whole portfolio by maximising lease length and minimising voids.
Occupier take-up has disappointed recently and reducing occupier risk will become more important if that trend continues. Keeping tenants in older stock, who would happily consolidate into new space, is becoming increasingly difficult and the market has not fully priced-in this risk.
Long-lease funds have performed worse than balanced and specialist funds for the past two years, but were top performers in the last slowdown. As the market slows, they should perform well.
Assets with non-business-cycle drivers, such as hotels, should provide diversification and potential outperformance. German and Italian gateway cities join London and Paris as areas of focus, offering a balance between leisure, business and tourism.
Debt markets also offer options, not just CRE, but residential and infrastructure debt, too. Competition is heating up among debt funds, but the larger ones still dominate. As we expand our debt platform, more options and expertise become available, further supporting our 360-degree approach to investing in real assets. The flexibility of movement between equity, debt, traditional real estate and alternatives will be vital as the cycle progresses.
UK real estate may have lost momentum but, for investors, it has not lost its importance. Given the market’s size and liquidity, it will continue to offer a range of investment options. But investing today requires caution and a more defensive, long-term mindset than previously. Even in our preferred sectors, stock selection is increasingly important.
Anne Kavanagh is global head of asset management and transactions at AXA Investment Managers - Real Assets