25 October 2016

Paul Clark: Risks ahead, but London still draws global capital

Paul Clark, Chief Investment Officer at The Crown Estate, explains that with fewer destinations for global capital, London's outlook remains strong.

As we enter the autumn after a politically noisy summer, there seems to be an air of pragmatism across the real estate sector. We have seen share prices rally after the referendum plunge, and some property funds have even re-opened their doors following a suspension. While the headlines continue to portray a mixed picture of Brexit’s overall impact, it would seem it has not been as severe as expected, at least in the short term, and in the long term it is still far too early to act or assess meaningfully.

So where are we now? Most people agree that, at least in the capital markets, we were past the top of the cycle before the referendum and that a softening was on the cards. While capital values overall are close to their 2007 peak, in central London they are beyond that point. In the occupational markets, both prime office and retail rents are well beyond previous peaks. However, for offices, at least in real terms, the picture is quite different in that affordability by historic standards looks OK.

So in a cyclical market, it looks like an adjustment but not a crash. The sector is not overdeveloping, nor is it highly leveraged. The volumes of global capital flowing into UK real estate remain elevated and this is particularly true for London. We enjoy the most genuinely globalised real estate market in the world, with the widest range of international investors we have ever seen.

"We enjoy the most genuinely globalised real estate market in the world, with the widest range of international investors we have ever seen.”

Paul Clark, Chief Investment Officer at The Crown Estate

Even allowing for the events of the past few months, UK real estate remains attractive, with net investment from abroad rising to £855m in August, most likely linked to the devaluation in sterling.

That said, there are risks on the horizon. The extended uncertainty of the EU exit negotiations and how smoothly that can be managed will be crucial. For financial services, clarity over retaining passporting and access to the single market will have a knock-on effect for the office market. In recent weeks, a number of major global banks have said they cannot afford to await the outcome, with estimates of between 40,000 and 80,000 jobs moving away from London. A weaker sterling and lower levels of business investment are also likely to lead to a squeeze on real incomes and in turn on retail margins.

Weaker valuations are, therefore, more likely to be based on less robust income streams rather than significant outward yield shift. However, if we step outside the narrow lens of our relationship with the EU, what is different about this cycle, compared with previous ones, is the general state of western economies, many of which are in special measures.

Here in the UK we have had record low interest rates since 2009, £435bn of quantitative easing in the system, record balance-of-payments deficits, increasing consumer debt and real wages that have declined by more than 10% since the global financial crisis. This is producing more volatile politics and, therefore, more volatile policy making.

Nonetheless, there are reasons to be confident about the resilience of the UK real estate sector over the long term. There is still a glut of global capital looking for places to invest, but with fewer attractive destinations. Aside from the advantage gained from a competitive devaluation, the fundamentals of London’s property sector remain a strong draw to global investors: from the depth, liquidity, transparency and professionalism of its markets through to its infrastructure, time zone and language. These are characteristics that are applicable to other sectors across the whole of the UK.

While the mayor has rightly launched an inquiry into the effect of this investment on London’s housing affordability, it has been transformative for the commercial property market. Take, for example, our £1bn regeneration of Regent Street with Norges Bank Real Estate Management.

For businesses with a long-term interest in London and the UK’s commercial property sector, continuing to attract and develop these kinds of partnerships will be critical to ensuring London remains a great city to live and work in during more uncertain times.

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