If you knew you were going to undergo an operation two years from now, would you do anything differently today?
UK households have decided that the prospect of Brexit is no reason to change their behaviour, for now at least. It might be because Brexit is too far off to worry about today, or that it is too abstract to see how it would affect us personally. After all, the UK is going under the knife, not you or me, right?
Brexit is a process and so an operation seems the most appropriate analogy - it is neither a sickness nor a cure. But far from distant, the process has already begun and the huge political upheaval and market volatility that followed the referendum defined 2016.
The one upside - the continued strength of the UK economy since the referendum - unfortunately provides real estate investors with little comfort. The UK economy had everything going for it in 2016: the Bank of England lowered interest rates and expanded its asset purchasing programme; sterling weakened but inflation remained low. Despite being in this sweet spot, UK real estate returns slowed to 3% for the year.
The UK faces the prospect of stronger economic headwinds in 2017, particularly if inflation rises sharply. In contrast, the rest of Europe continues its slow but predictable recovery. The euro area unemployment rate breached a psychological barrier by falling below 10% in October last year. That level of unemployment is not a signal that the recovery is complete; the euro area is only just getting back to a level where the US and the UK began their recoveries more than five years ago. Importantly, however, there has been enough progress in the labour market to have a positive impact on office vacancy rates and, in turn, rental growth.
Taking a more global view, inflation is back and its return has revived investors’ expectations for growth. In turn, bond yields and commodity prices have risen. However, these movements are relative to last year. We believe strongly that higher yields are here to stay but that we are moving into a period of normalisation rather than a step-change in our global outlook.
On balance, investor interests are likely to shift from the UK to continental Europe. However, an ideal investment strategy for both the UK and the rest of Europe should largely focus on low-risk, core assets.
One trend that is likely to continue in the UK and beyond is further investment in alternative property types with non-business cycle drivers. For example, student housing has become an increasingly attractive property type. Structural growth in global student numbers, alongside low levels of purpose-built student housing, have made student accommodation an interesting addition to more cyclical property asset classes.
Other alternatives, such as hotels, healthcare and data centres, each have their own long-term drivers of demand and offer a wide range of risk-return options. Regardless of a country’s political climate or short-term economic prospects, we are still likely to see growing tourist arrivals into Europe, we still have ageing populations and we still need to ramp-up our data storage. While alternative property types remain niche long-term investments, we view them as essential diversifiers, particularly in today’s environment.
This year is likely to see a push for core real estate as a number of political events unfold. The definition of core should extend to a range of property types but be restricted to only the largest liquid locations. The goal is to secure diverse, high-quality income streams for the long term. UK-focused investors should not overlook opportunities, but enhancing their income profiles is the priority. Think of it as insurance for any post-op difficulties.