The widely accepted view that the UK property market has performed better than expected following the shock EU referendum result last June may be wishful thinking, attendees have heard at the EPRA Insight 2017 conference in London.
Property values are down by 3%, much less than feared, and sentiment has not collapsed. However, the sense of relief that is widely felt is illusory, said Bart Gysens, head of property research at Morgan Stanley, said during his presentation to the annual listed property event organised by the European Public Real Estate Association (EPRA) on Monday evening.
'The fact is that sterling weakness is masking and moderating capital value weakness. In dollar terms 2016 has been the third worst year ever for commercial property volumes,' Gysens said.
Looking ahead, 'investment volumes continue coming down and, as volumes are correlated to prices, that is not a good thing,' he said. 'And it is not just institutions and companies, but also retail investors that are taking money out of commercial real estate.'
Brexit may not be entirely to blame, he added, as the cycle was already advanced, so the referendum result could have just accelerated an existing trend.
Drilling down into the different sectors, Gysens predicted that offices will be hard hit by the slowdown, compounded by the uncertainty surrounding Brexit. 'Office vacancies are set to rise, we expect quite a sharp pick-up,' he said. ‘It will be back to 2009 levels before too long, and quite soon the power will shift from landlord to tenant and rents will start to fall.'
In London office rents are likely to fall by 10%, or up to -25% under the worst-case scenario of an exodus of companies from the City following a hard Brexit. Capital values will fall by 6%, Gysens said.
The retail sector will not fare much better, according to the Morgan Stanley head of property research. Sterling weakness might have brought higher footfall in London and brisk sales to tourists, but it has also brought imported inflation which will hit UK-wide consumption and retailers' margins.
For the London residential sector, currently undergoing a correction after years of substantial price increases, the main worry is taxation and government intervention. In her speech at the Conservative Party Conference, Prime Minister Theresa May said that 'a change has got to come. And we are going to deliver it.' This is worrying, Gysens said, as it shows that 'the Government is leaning into property.'
There is a flipside to this rather gloomy scenario, though. 'Logistics is the only bright spot in the UK property market,' Gysens said. 'Vacancy rates have dropped from 10% to 5% and increased demand has not been matched by rising supply, giving landlord unprecedented pricing power.' Rents in the logistics sector are expected to rise by up to 5%, while capital values will increase by up to 7%, he said.