40 global cities by 2025 with 10 million + populations.1 The focus on Winning Cities with faster growth in jobs and locations where people wish to live and work.
We are living longer and moving closer to cities.2 The focus is on real estate which attracts multiple types of uses and benefits from structural changes, e.g. hotels, care homes, office and retail.
The locations which attract the TMT sector and demand for e-commerce will capture high growth.3
Global demand for power and infrastructure is increasing.4 Locations with better infrastructure, resources and power will thrive.
The shift of economic growth from West to East is changing demand. The focus is on locations that attract businesses which benefit from increasing demand from the East, such as luxury goods and education. 5
Positively impacting the environment, society, and investment returns.
Source: 1: IDC (2017), 2: International Energy Agency (2017), 3: Oxford Economics (2018), 4: United Nations (2016), 5: World Bank (2017).
While economic growth has slowed in most countries this year, the UK has seen a relatively sharp slowdown due to the uncertainty around Brexit. Our central forecast assumes that Parliament forces the Prime Minister to ask for a further delay beyond October, that the EU agrees and that there is then a general election where voters reject the option of a no-deal Brexit. In this scenario, Schroders expects that the UK economy will grow by 1% p.a. through 2019-2020, inflation will be around 2% and the Bank of England will raise the base rate to 1% by the end of next year. However, politics is fluid and the UK could leave without a deal, either on 31 October or after an election. If that happens, then the economy could suffer a mini-recession in 2020.
Office take-up was steady through the first nine months of 2019, with tech, media and serviced office providers making up for lower demand from banks and professional services. In general, office markets appear to be well placed to withstand a period of economic weakness. In most cities vacancy rates are close to their low point before the financial crisis and new building is limited, or in the City of London set to fall sharply in 2021. However, there are two caveats. First, Brexit will cut demand for London office space from financial services. The size of the impact will depend on the type of Brexit. Second, serviced office providers (e.g. Wework) have recently been an important source of demand, particularly in London and Birmingham, but it is unclear how resilient they would be in a downturn. Usage could fall sharply if companies cutback on overflow space and some providers have signed long leases with landlords at high rents.
Industrial rental growth has eased to 3% this year from 5% in 2018. In part this reflects weaker demand from manufacturers who account for roughly a quarter of space and in part it is due to an increase in vacant distribution warehouses. The last two years have seen an increase in speculative development of big distribution units and retailer insolvencies have added empty space. Moreover, there are signs that occupiers in London are starting to balk at further rent increases, following a 40% rise since 2014. We expect that distribution warehouse rents will be stable over the next 18 months. Rents on multi-let industrial estates will probably increase slowly, reflecting the continued growth of last-mile deliveries and low levels of new building.
The retail sector continues to be challenging. While this year has seen fewer administrations than in 2018, several retailers have announced store closures and retailers are increasingly asking for large cuts in rent, either at lease expiry or in exchange for lease extensions, or store improvements. We expect retail rents to fall by 20% on average over the next five years, as online sales increase from 19% of total retail sales today to between 25-30%. Lower rents will encourage some retailers (e.g. discounters) and leisure operators (e.g. gyms, vegan restaurants) to expand, but they are unlikely to fill all the vacant space. The other part of the solution will be to redevelop and convert retail schemes to other uses, particularly residential. That should be viable in big city centres and affluent towns, but it will be more difficult in towns with weak economies where there is less demand from competing uses.
The investment market remains polarised. On the one hand, the insecurity of rental income makes it difficult to price many retail assets and the value of shopping centre deals has sunk to the depressed levels of 2008-2009. Yields on shopping centres and retail parks have risen by 0.6% over the last 12 months and we expect them to continue to rise through 2020. On the other hand, there is strong demand for supermarkets with long leases and index-linked rents, prime offices and prime industrials. A Brexit deal could trigger a new inflow of foreign capital, particularly into the London office market where yields are 0.5-1.0% higher than in Paris and Berlin, although UK finance costs are correspondingly higher. The weakness of sterling may also be an attraction for some overseas investors. In addition, both domestic and foreign investors continue to invest heavily in student and private rented accommodation. Residential and alternatives share of total transactions climbed to 32% by value in the first nine months of 2019, from under 20% three years ago.
We forecast low single digit all property total returns in 2019, but the average will mask a huge variation across different types of real estate. For example, secondary shopping centre values could fall by 20% or more this year, whereas industrial and regional office capital values should be stable, assuming the economy avoids a recession. Our main focus for diversified portfolios is on industrial / logistics serving large population centres and offices in winning cities such as Bristol, Leeds and Manchester. We also like certain niche types such as retirement villages and social supported housing where demand is driven by long-term structural factors independent of the economy and where there is a shortage of good quality purpose-built accommodation.
|Q3/2018 - Q3/2019||Q3/2017 - Q3/2018||Q3/2016 - Q3/2017||Q3/2015 - Q3/2016||Q3/2014 - Q3/2015|
|Net Asset Value total return2||2.8||8.9||11.8||4.4||15.4|
|SREIT Real Estate Total Return3||5.2||11.0||12.2||6.6||15.2|
|MSCI Quarterly Version of Balanced Monthly Index Funds3||2.5||8.6||9.7||4.2||14.0|
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested.
1 Source: Schroders, Datastream, bid to bid price with net income reinvested in GBP.
2 Source: Schroders, NAV to NAV (per share) plus dividends paid.
3 Source: MSCI Quarterly Version of Balanced Monthly Invex Funds (including indirect investments on a like-for-like basis.
Investments in real estate are relatively illiquid and more difficult to realise than equities or bonds.
Yields may vary and are not guaranteed.
The use of gearing is likely to lead to volatility in the Net Asset Value ("NAV") meaning that a relatively small movement either down or up in the value of the Company's total assets will result in a magnified movement in the same direction of that NAV.
There is no guarantee that the market price of shares in a UK Real Estate Investment Trust such as SREIT will fully reflect their underlying NAV.
The value of real estate is a matter of a valuer's opinion rather than fact.
This UK Real Estate Investment Trust should be considered only as part of a balanced portfolio, of which it should not form a disproportionate part.