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2017 Predictions: Surprise of 2017 could be the bounce-back of UK real estate

What a year 2016 was! Who would have thought last January that the UK would vote to leave the European Union, Donald Trump would win the US election and Leicester City would win the Premier League.

Allan Lockhart
What is even more surprising is that the markets liked these outcomes: the FTSE 100 and S&P 500 closed on 30 December at near all-time highs, even with the Italians voting ‘no’ to constitutional reform.

Unfortunately, the same cannot be said of the UK quoted real estate sector, which significantly underperformed relative to the FTSE 350 Index.

Indeed, 2016 was the worst year since 2007 and the third worst for 20 years. Conversely, global real estate performed well, delivering a total return of 8.1% compared with global equities at 9.9% and global bonds at 2.9%.

But as Amos Tversky, the renowned cognitive and mathematical psychologist, said: “He who sees the past as surprise-free is bound to have a future full of surprises.” So could the UK-quoted real estate sector surprise the markets with a bounce-back in 2017?

Outlook doesn’t look great for US real estate
According to EPRA, North American real estate delivered a total return of 11.4%, Asia 9.3% and Europe (excluding the UK) 5.1%. In stark contrast, the UK delivered a total return of -8.5% in spite of its economy performing well last year. Clearly Brexit meant Brexit for UK real estate.

Moreover, according to the new narrative of rising US bond yields, higher inflation and higher interest rates, particularly in the US, the outlook doesn’t look great for real estate without higher growth in the economy – or mixed at best.

Specialists on top
For the past three years, I have highlighted the performance of UK-quoted real estate companies with predominantly UK-focused portfolios and a market capitalisation in excess of £100m. With the exception of Secure Income REIT, whose total shareholder return (TSR) performance was outstanding at 30%, the TSR for the companies highlighted in the table ranged from 15% to -36%.

Only 14 companies delivered a positive capital return, although taking into account dividends declared, 21 companies did so. Even then, only one company actually beat the FTSE All-Share Index.

Once again, it is companies that are either specialists and/or income-focused that occupy the top positions in the league table.

Companies that are more London-focused and/or development-focused and have benefited from significant development profits in recent years have been hit hard by equity investors.

Listed real estate companies ranked by total shareholder return in 2016
Company TSR Approx market cap (£m)
1 Secure Income REIT 30% 717
2 FTSE 100 19%
3 FTSE All-Share 17%
4 Tritax Big Box REIT 15% 1,542
5 MedicX Fund 13%
6 Picton Prop Income 11%
7 Target Healthcare 11% 285
8 SEGRO Plc 11% 3,803
9 Regional REIT 9% 296
10 Custodian REIT 9% 353
11 Primary Health 8% 666
12 Assura 7% 942
13 S Life Inv Prop Trust 7% 329
14 FTSE 250 7%
15 F&C Comm Prop Trust 6%
16 NewRiver REIT 5% 797
17 Grainger 4% 991
18 UK Comm Prop Trust 4%
19 Hansteen Holdings 4% 845
20 F&C UK RE Inv 3% 236
21 AEW UK REIT 1% 118
22 Safestore Holdings 1% 730
23 Shaftesbury 1% 2,536
24 Schroder RE Inv Trust 0% 296
25 LondonMetric -1% 971
26 Hammerson -1% 4,545
27 Daejan Holdings -1% 1,009
28 ESP Empiric Student -1% 531
29 Mountview Estates -3% 431
30 A&J Mucklow Group -4% 294
31 UNITE Group -5% 1,345
32 Land Secs Group -6% 8,429
33 Intu -7% 3,812
34 FTSE 350 Real Est -7%
35 Conygar Investment -9% 112
36 Capital & Regional -11% 386
37 Big Yellow Group -12% 1,082
38 Town Centre Secs -12% 147
39 Redefine Int -15% 710
40 Workspace Group -16% 1,293
41 CLS Holdings -16% 623
42 British Land -16% 6,482
43 Kennedy Wilson Eur -17% 1,210
44 Great Portland Est -18% 2,299
45 U+I -18% 213
46 Derwent London -23% 3,088
47 St Modwen -25% 674
48 McKay Securities -31% 163
49 Capital & Counties -32% 2,514
50 Helical -36% 348
Where no Market Cap is supplied for non-index entries, no information was available. Companies listed in blue are REITs. Source: Bloomberg

But are the markets overstating the case for higher bond yields and interest rates? Research from the Bank of England shows that interest rates have been declining for 35 years. The main reason is the supply of savings far exceeding demand for investment, thus lowering interest rates as well as the cost of capital.

An ageing and more slowly growing population, income inequality and lower productivity are the main drivers for the savings glut and lower investment demand. These demographic trends are very likely to continue supporting lower demand for capital and thus lower interest rates for longer.

Attractive and secure return
Our basket of listed real estate companies currently returns a dividend yield of circa 3.6%, so in a world of excess capital I believe a sustainable income underpinned by recurring cash revenue streams from a diversified occupier base provides an attractive and secure return.

That leaves Brexit. Given the fall in the value of sterling, the effective price for UK real estate for international buyers is very attractive and perhaps this will support values, particularly for the London market. In addition, it is highly unlikely that the terms of the EU divorce will be apparent until well into 2018.

Many of the quoted real estate firms are well placed to face the challenges and likely volatility of 2017 given their high-quality management teams and conservative balance sheets, so perhaps the surprise of 2017 will be the outperformance of the UK-quoted real estate sector against the wider equity markets.

Allan Lockhart is property director at NewRiver REIT

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