Professionals and investors alike frequently ask me if I believe that the UK property market is at its peak? Despite having lived through four property corrections I can honestly say I really don’t know.
The residential market has become increasingly commoditised and valuation comparables are readily available. There has been a correction at the high end, especially in the metropolitan areas but supply and demand in the sub £600 per sq. ft. has remained robust.
Commercial property, on the other hand, is far harder to gauge. Low interest rates and quantative easing have seen commercial real estate yields compress dramatically since the last correction in 2008, both in prime and secondary markets. This has been coupled with strong rental growth. Commercial valuations are based on the investment method of valuation with rent and yields being derived from earlier market transactions. They are therefore subject up to a six-month time lag. They trend up on rising markets and dramatically fall in times of crisis or uncertainty when transactions are scarce and those available have traded in thin markets.
The current property cycle is 10 years old, the longest sustainable period to date in the UK. With yields at historically low points, especially for prime and well-located stock, the indicators are saying that a correction is imminent. However, professional valuers are split over whether we are at the zenith of the cycle.
As people seek income and wealth preservation, property has become a logical asset in which to seek security, both for domestic and foreign investors. Across the investment spectrum the stock market is at historically high levels, assets such as cars, wine and art look fully priced and the bond market is as fragile as ever. So, property stands out as a tangible asset with both income and long-term capital preservation qualities.
This is not to say that capital values may not correct in the short- to medium-term. I do believe this to be highly likely. But unlike during previous cycles this will not be a demand or supply correction, as in 1988, nor a debt driven one as in 2008. It will most likely result from a shock geopolitical event. The Brexit result had a small and temporary effect on value but that was quickly reversed, especially by foreign capital seeking a safe haven and benefitting from the subsequent weakness in sterling. Despite more recent global political tensions and terrorist threats, the UK property market has remained remarkably robust and resilient.
Notwithstanding the peaks and troughs of the commercial property market, its long-term performance has been robust, delivering on average 10 per cent total return per annum. However, the divergence between top and bottom of the cycles has been as much as 40 per cent in certain subsectors.
Residential property is easier to predict and price. Given the huge demand supply in balance the buy-to-let and rental market would seem fair value. The commercial property market, on the other hand, is far less transparent, especially in the secondary and alternative sectors.
Most professionals would agree valuations are full but that misses the point about commercial property. It should be viewed as a long-term investment which, with proper asset management, good location and planned maintenance delivers both predictable income streams and through upward only rent reviews, a natural hedge against inflation. The 25-year upward only lease has gone but the ability to work with tenants and deliver modern useable space allows far more proactive management and enhancement of income streams.
All wealth planning strategies should consider real estate as a long-time investment. Valuations and market commentary might be more cautious right now but are very much spot-pricing at the moment; the true worth of the property is the potential income and capital enhancement it can deliver.
Is it time to sell? Potentially, but realising a capital gain at this point in time and forgoing income begs the question: what else can you invest in that is safe, inflation resistant and has a long-term future upward potential?
I believe that this is still a good time to invest in property. The caveat is that beyond the maxim of Location Location Location, stock selection, geographic and tenant diversity are essential. In the short-term capital values will fall, some will lose if forced sellers, others will win on the upswing. But the true worth potential will be for those who buy well and hold.
Chris Horler MRICS is Director of Arbuthnot Latham Real Estate Investors
