Foreign investors were net sellers of £8.2bn of gilts last month as political risk was priced in, but this has been offset by net buying by UK institutions adjusting to a low-yield environment and rotating out of fixed income and into equities and real estate.
The main operating feature for real-estate investment trusts (REITs) has been Land Securities, British Land and Hammerson locking into £2.2bn of bank money ahead of five-year gilt yields shifting from 0.9% to 1.3%.
Writing before the outcome of the general election, it seems that neither the Tories nor Labour will win an overall majority, and the problem with the Fixed-Term Parliaments Act is that a two-thirds majority in the Commons is needed to call another general election.
That could mean a zombie government for five years, putting at risk the UK’s credit rating, which memorably lost its unimpeachable AAA status in 2013.
Demand for prime real estate remains substantial, as shown by Great Portland Estate’s joint-venture sale of 95 Wigmore Street, W1, for £222m, having been put on the market for £190m. That is a capital value of £2,209/sq ft or 3.4% initial yield, which is white-hot pricing for ‘Chipboard Alley’ north of Oxford Street, and Great Portland Estates has probably locked into a near-100% developer’s profit.
These low yields remain a function of global stimulus, which makes 3.4% look good relative value, with safe-haven status enhanced by the risk of Greece exiting the eurozone.
A ‘Grexit’ would be less manageable than the market thinks, and could spur the European Central Bank into stepping into buying paper from the existing €60bn (£44bn) a month quantitive easing programme.
The real worry is that US and UK growth sputtered in the first quarter. The world’s largest economy grew by a meagre 0.2% after 2.2% in the final three months of 2014, and the UK slowed to 0.3% with service-sector growth offset by falling construction output. The prospect of the US Fed and Bank of England raising rates this year has all but evaporated and inflation remains weak. That isn’t enough to fill voters with confidence in the coalition’s economic track record but it’s also too high for rivals to damn it.
What is becoming apparent is that there is a chronic lack of demand; developed economies stall without stimulus. What’s good for bond yields and real estate cap rates is, however, bad for rental growth. That is why REIT shares have crabbed sideways over the past few months despite universal enthusiasm for Land Securities and British Land with a slew of share-price target upgrades ahead of them announcing their March portfolio revaluations.
Average NAV growth across UK REITs peaked at 16% last September and with that the sector sprinted into 2015. What property shares do now, the direct market tends to follow around six to nine months later.
REIT shares are now capitalised at £62bn but that equity capital is forward-looking and smart while valuation of the £1 trillion commercial property sector is sticky and backward-looking.
REITs may be up 20% over the past 12 months, but this performance was concentrated between October and February, since which the UK IPD ‘All Property’ Capital Value Index has slowed, with quarterly data annualised dropping from 15% to 6%. REITs have lost momentum for a reason and analysts may be building undeliverable growth into their share-price targets.
Mike Prew is managing director and head of real estate at Jefferies