07 June 2017

Paul Clark: Thriving through a period of lower returns

Paul Clark, Chief Investment Officer at The Crown Estate, on the strength and consistency of UK real estate against the backdrop of an economy in special measures.

Since the worst of the downturn, UK real estate has produced consistently strong returns. This is something which our sector is, quite rightly, proud of and has helped fuel global interest in UK real estate. So whilst our sector continues to feel optimistic about its place in the world, the reality for the country as a whole has been rather different. 

Added to that, growth in household earnings has been anaemic at best over the last decade. Average household debt is on its way back up, whilst saving rates have reduced to levels last seen fifty years ago. As inflation rises, standards of living will also continue to come under increasing pressure.

All of this is against a backdrop of continued record low interest rates and huge amounts of QE sloshing around the system.

So why have total returns from property been so robust against the backdrop of an economy in special measures? Given that real estate should be a factor of production, why the disparity?

"UK property, in particular, stands out to international investors who have seen their investment options narrow with increasing global instability.”

Paul Clark, Chief Investment Officer at The Crown Estate

Well, first and foremost it is those special measures which have had such a positive impact on the investment environment. With an exceptionally low risk free rate and major bond purchasing activity from central banks, the glut of global savings has found it harder to find a suitable home and real estate continues to offer attractive, stable income returns.

UK property, in particular, stands out to international investors who have seen their investment options narrow with increasing global instability. There is much in our favour; deep, liquid and transparent markets, the rule of law, time zone, with a language advantage and a relatively benign taxation regime.

However, there is no doubt that business activity, especially in central London, has slowed recently and, for a while at least, we cannot rely on the consumer to be the engine of the economy. Not surprisingly, forecasts confirm we are heading into a period of lower returns.

Not that this means a major downturn is likely; the factors already outlined mitigate against that. What’s more we have neither over-leveraged nor over-developed during the last upturn. Consequently we look to be heading into a modest slowdown rather than anything worse. Transaction levels are lower and there are fewer active buyers out there, but yields on prime real estate remain, for the most part, stable.

However, the UK has experienced four seismic political events over the past four years and it is hardly the beacon of stability it might once have been. For example, our industry is already feeling the impact of less-technocratic, more politicised decision-making in relation to the taxation on high end residential.

Furthermore, interest rates are pretty much as low as they can go. This leaves the Bank of England with very little wiggle room for further loosening of monetary policy.

If UK real estate is to maintain healthy returns in this subdued environment, then it needs to get back to basics. This requires businesses to take a broader, long term view; to look through market cycles, rather than react to them.

At The Crown Estate this means focusing on the sectors we know and understand, and concentrating stock selection on quality and where we have critical mass and expertise. It also underlines the importance of active asset management to drive income growth, which will be the key component of total return outperformance.

So for us, the next few years will be characterised by a concentration on these fundamentals. On continuing to create brilliant places that deliver consistently strong returns but also enhance the communities and environments in which they sit. To do that successfully requires a real understanding of, and empathy with, stakeholders and customers, which is only possible when a business is truly embedded in a sector and a locality. 

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