Property predictions 2016 8th December 2015

Total commercial property returns will halve in 2016 year on year from 2015 to 7.5% with a swing to income and risk the key investor themes and a number of areas continuing to offer significant opportunities strong performance. Savills took out its crystal ball this morning to review the year ahead and forecast its top picks for investors.

Savills unveiled its predictions for UK real estate at its annual cross-sector briefing this morning, taking a detailed look at the commercial, residential and agricultural markets.

Matt Oakley, Savills’ head of commercial research, celebrating his birthday this morning, said Savills’ house view was for average total returns on UK commercial property investments to slow to approximately 7.5% in 2016, down from an admittedly strong 14.5% in 2015 and down from a five year average of 10%.

Oakley said investors will need to focus more on rental growth than capital growth.

Oakley predicted 2015 will chalk up record transaction figures of around £70bn in the UK, a figure that would fall in 2016 but likely remain ahead of the long-term average.

There will be a rise in demand from institutional investors looking for longer-income asset management and alternative asset classes, Savills said.

Oakley said for investors who bought in 2008-2012 now remains a good time to sell as rising sovereign bond yields in particular in 2017 are likely to make commercial property less appealing as an asset class leading to slowing returns in commercial property yields in the next four to five years.

“In recent times investors have notably swung from seeking capital value growth to seeking income and risk and that will be the theme going forward,” Oakley said.

Oakley said within this context the focus must be on where capital values have not corrected as well as asset management, development and rental growth opportunities.

Looking ahead Oakley pointed to a number of key areas for outperformance.

• Smaller lots of between £5m and £15m will provide a "rich opportunity for opportunistic buyers and private investors looking to create larger portfolios for eventual sale to institutions". Oakley said there was a 50 to 200 bps difference on where prices were in 2000 and 2007.

• Scotland in particular looks cheap, Oakley said, with all sectors 70 to 150 bps higher in terms of yield to comparable English cities. Oakley said there had been an “over-egging” of the political risks in Scotland.

• Good quality refurbished office space in the UK’s top seven major cities will experience stronger than average rental growth, reaching levels recently seen for similar assets in London

• The retail market in many of the UK’s regional towns and cities has now rebased to a level where retailers can trade profitably, and the outlook for retail rental growth in 2016 in these locations is stronger. Most retailers have “got their heads around” the internet and its challenges, Oakley said.

• Prime West End retail rents will continue to rise at over 6% per year

• There are still good opportunities in the core industrial distribution markets for investors if they can locate appropriate sites, with the best prospects in the under-supplied middle of the country. “Urban industrial estates are suddenly very institutional both in terms of buyers and tenants. The opportunity to convert to residential could be the great undiscovered goldmine.”

Focusing on the potential for rental and income growth Oakley said the key opportunities related to:

  • Offices – Northshoring; core to fringe in most cities; labour pools
  • Retail – London retail will outperform; retail warehouses as the most “internet friendly” assets; experience-led malls; convenience high street
  • Industrial – big sheds; ports-based development; urban logistics and last-mile
  • Alternative assets – Anything that delivers stable income – student housing, hotels, data centres – will be bankable and emerging sectors are set to perform well.

Elsewhere, the forecast is for average UK house prices to rise 5% in 2016, but the speed and timing of interest rate rises will dictate the pace and sustainability of price growth.

Income and the ability to unlock the latent value of individual assets through active management are likely to be priorities, due to the current stage of the property cycle and the medium-term prospect of interest rate rises, regulation and tax policy in the residential sector, and the outlook for commodity prices in the agricultural sector. In the commercial and residential markets Savills expects a shift towards investment in regional markets, given where recent capital growth has left yields.

The referendum on membership of the European Union (EU) presents the greatest uncertainty for UK real estate in 2016/17, according to Savills, the outcome having potential implications for all three sectors. The prospects for a pre-referendum investment slow down may well depend on how close polling companies believe the outcome will be.

Mark Ridley, Chief Executive Officer, Savills UK and Europe, said: “Next year UK real estate will move into a new stage of the property cycle and will also face a number of ‘known unknowns’: an in-out EU referendum within the next 18 months, new regulation coming into force, and a potential end to more than six years of record-low interest rates, resulting in a very different year to 2015. As we’re unlikely to see a repeat of the strong capital growth witnessed recently, we’re predicting that investors’ attention will turn to maximising rental growth and income returns. There are still numerous opportunities across all the sectors we’ve explored, however, particularly outside the capital, and we expect to see the shift towards investment in the regions that began this year to strengthen in 2016.”