It might be impossible to look anywhere without seeing a mention of Brexit, but the reality is that life goes on for UK plc. And while there is always going to be a measure of uncertainty over the final details, day-to-day business will continue. And for the foreseeable future, the fundamentals in the commercial property sector are likely to remain favourable. Overseas investors seem to think so as well, with the UK attracting more than half the capital coming from Asia into Europe, and Germany coming a distant second with just 12 per cent.
However, investors are likely to remain selective, with office and logistics assets attracting more attention than retail assets. There will also continue to be geographical preferences, with regional areas outside London continuing to attract investment. In particular, multi-let industrial units are pulling in fresh money. And while capital growth will continue, yield compression has been significant, which suggests that future rental growth is being overpaid for upfront.
Excluding the London market, where Brexit jitters are the most pronounced, the outlook for the office sector looks remarkably bright. There are a number of supporting pillars here, and none of them looks likely to crumble in the near term. Office supply is likely to remain limited because benign rental growth over the past decade has made it unattractive to build new offices, simply because of the high cost of construction. And the existing stock is slowly being chewed away by conversions into residential accommodation. In some areas, there is not a single vacant office, good news for existing landlords because for the first time in a long time rents are starting to rise at a decent rate.
Inside London there has been a different picture. The market cooled somewhat following the referendum, but rents are again being underpinned by a lack of supply. Speculative development is now predominantly a thing of the past, with landlords looking to focus on long leases and recurring rental income. Overseas buyers seem to be unperturbed by the dire warnings of a mass exodus in the financial sector, with investment in the first three quarters of 2017 up significantly from a year earlier. As regards to rents, the jury remains out. If 70,000 jobs (or less than 4 per cent of office workers in London) were to go, there would certainly be a modest reduction in rents, but not uniformly, with areas such as the West End, where new supply is virtually non-existent, weathering the storm better than most. In fact, the take-up of office space in the West End is currently higher than at any time since 2006. And even in the City take-up is on the rise, which suggests that the post-referendum reaction has been overdone.
One potential game changer is a proposal to charge overseas investors capital gains tax. The new rules are set to come into force in April 2019. The Treasury maintains that the move will reduce the incentive for multinational groups to hold UK property through offshore structures often in low- or no-tax jurisdictions. High-value structures such as the Walkie Talkie and the Shard, as examples, have been financed by overseas investors. However, the ruling does bring the UK tax system into line with most other advanced economies.
Changing consumer habits, especially buying online, will continue to keep demand brisk for logistics warehouses. Retailers need to build a network of distribution centres to meet growing demand, and until recently a total lack of new build has helped to underpin rates. The supply/demand imbalance is starting to narrow, but landlords are still well placed, favouring the long lease arrangement with annual uplift only in rents. There could even be new avenues of demand, with suggestions that an end to free trade with the European Union could lead to a significant increase in demand for bonded warehouses around the UK’s main ports.
Another sub-sector that is likely to remain strong is student accommodation. The key point here is that there is an excess of students over university places. Last year 540,000 found a place, but there were 725,000 applications. There is still a lot of interest from overseas students despite the uncertainty caused by Brexit, and companies such as Unite (UTG) are running on near full occupancy. That means that rental growth is pretty much assured, and rents are expected to rise around 3 per cent in the new year.
While retail properties, or more specifically very large supermarkets, remain less attractive, there are still pockets that are likely to do well. Once again, this is a product of changing consumer habits, where the big weekly shop is giving way to more convenience-style shopping. This is an area that companies such as NewRiver Reit (NRR) will continue to exploit, and in the case of NewRiver it has also acquired a number of pubs, where redundant car parking space has been utilised to make way for convenience stores.
Commercial property will retain its attraction thanks to a growing economy and a lack of supply. Higher interest rates are unlikely to blunt demand because historically they are still at very low levels.
Still room at the inn for the buy-to-let landlord
Buy-to-rent landlords have been the target of much legislation in the past couple of years, and it is likely that the market will never be the same again. Without doubt, landlords with larger portfolios have weathered the storm a lot better than those with just one or two properties.
Increasing stamp duty on secondary homes and phasing out full tax relief on mortgages were useful tools for the Treasury to raise funds, but after that, the motives remain cloudy. There were suggestions that with landlords selling up there would be more properties for prospective buyers, but this hasn’t been the case. In more desirable areas, tenants can afford the rent but could never afford to buy the property.
There are also lifestyle issues. Many people rent by choice, unwilling to make a commitment. Renting offers flexibility for people moving location, and is usually preferred by people experiencing social changes such as divorce. In fact, the Royal Institute of Chartered Surveyors has predicted that 1.8m new rental homes will be needed by 2025. Already, the total amount of rent paid to private landlords is more than double the amount of mortgage interest paid by homeowners.
The government’s recent focus is on increasing the number of houses built each year. This is entirely laudable, but measures to accelerate housing completions to 300,000 a year will take years to effect. And even measures to help first-time buyers are unlikely to make houses in the south-east of the country really affordable, which means that renting will be the obvious option.
Landlords have adapted in some ways to the more regulated regime by focusing on areas where yields are more attractive. This means moving out of London and the south-east, and into areas in northern England where house prices are that much lower. According to Hometrack, the gap between average earnings and house prices in London reached an all-time high of 14.5, whereas in cities such as Glasgow, Liverpool and Newcastle, the ratio remains below the 15-year average, with all at less than 5.0.
It’s not all plain sailing, though, because applying for a new buy-to-let mortgage from a high-street bank is being made more difficult as a result of stricter lending requirements. However, remortgaging on existing properties has been brisk so that in the past year a record 65 per cent of landlord purchases have been made in cash. More has been spent in cash in the past year than at any year in the past decade. And around three-quarters of properties bought in northern England were paid for in cash while London was the only region where buying with a mortgage outpaced cash buyers.
That regional difference is also explained by the fact that whereas rents in London have been flat or down, rents in the Midlands have been growing by over 2 per cent. And getting in now could be important because with a resurgence in economic activity and investment, capital values are expected to rise at a much faster pace than in London and the south-east.
If you are looking for a buy-to-let mortgage, it’s not all doom and gloom because there is now greater access to a number of specialist lenders, and in fact gross lending was slightly up from a year earlier. However, it’s important to remember that a majority of landlords own their property portfolio outright. So, if you have no mortgage and don’t intend buying any more properties, you were largely unaffected by the latest raft of legislation.
However, the buy-to-let landlord is still attracting attention from the Treasury because just recently the capital gains indexation allowance on an asset such as property has been removed. This means that any capital gains tax burden cannot now be reduced by adjusting the gain for inflation. There is one piece of good news, and that is the consultation on longer leases. These would be welcome all round because it will provide landlords with greater earnings visibility and also provides greater peace of mind for tenants.
Perhaps the major development could be growing interest in the build-to-rent market. Institutional funds, starved of a decent return from government bonds, are now percolating into the rental sector. However, it’s early days, and if demand for rented accommodation is set to continue growing there will still be a place for the private landlord. However, professional landlords have built their property holdings over a number of years, with many established as companies which carries numerous tax advantages. For the newcomer looking to buy just one property, the barriers to entry may be just enough to make many potential entrants think again.
