DWS: UK investment returns will continue to decelerate but ‘no-deal’ Brexit still expected to be avoided

Investment returns across UK real estate are decelerating but include a wide dispersion across property types, according to DWS updated H2 market outlook.

Real estate has not been immune to the political and economic uncertainty that looms large over the UK, DWS says. While short-term prospects are unclear, the outlook for rents and capital values will likely be determined by the nature of the withdrawal from the EU. DWS’ central case still remains that some form of agreement will ultimately be reached, and an orderly Brexit will be achieved.

In such a scenario, the UK market could on average be a relative outperformer, DWS forecasts, which states:

  • Central London office demand held up in 2018, driven by serviced offices and some large relocations but conditions have weakened so far this year. Headline rents are stable in the City and declining in the West End, but incentives remain generous while the regions have proved to be resilient so far.
  • Retail returns fell further into negative territory with rents continuing to decline. Consumer confidence remains at a low ebb, leading to lower in-store sales, while retail margins are being squeezed by rising costs and online retail continues to negatively impact in-store sales. This, in turn, led to a spike in store closures in 2018 with this continuing so far this year.
  • Logistics remains an outperformer, albeit returns are slowing. While demand for space remains elevated, with the sector benefitting from online retail, in turn underpinning strong rental and capital growth, the story is not uniform.
  • a wave of logistics development has seen average vacancy rise to almost 9%. With Brexit uncertainty and increased margin pressure affecting 3PLs, DWS anticipates rent prospects to remain flat for big box assets in the near-term albeit we expect urban logistics to outperform.
  • Alternatives such as apartments, hotels and student accommodation have displayed strong performance with these sectors benefitting from long-term structural trends. We consider a relative hedge to political and economic cycles and we expect their outperformance should be sustained in future.

Simon Wallace, Head of Research, Europe, at DWS, explains:

“Prime office yields look attractive relative to Europe albeit the spread partially reflects a ‘Brexit’ premium. Although headline rents have not seen major falls, incentives remain generous in Central London. While we have revised up our rental outlook in the near-term, we expect rents to recover more aggressively in the early part of the next decade as GDP growth strengthens, assuming Brexit uncertainty is lifted and confidence returns, particularly as supply moderates.

“While office demand has been solid in regional markets, we expect rent growth to moderate in the near-term. But once an expected economic recovery gathers momentum in the early 2020s, we could see a return to stronger rent growth thereafter.

“While we believe short-term performance in the logistics segment should remain positive, yields are relatively low while development activity is tracking higher.

“Retail continues to re-price and the sector faces several headwinds which in turn is negatively impacting investor sentiment. We maintain a high level of caution on the sector but in time tactical opportunities may well emerge to acquire high quality assets at discounts, as prices continue to adjust.

“We remain optimistic on alternative segments such as student accommodation particularly in locations with under-supply and strong demand fundamentals. In the hotel space, we think emerging branded serviced apartments or emerging hotel concepts could outperform. While the risk of a ‘no-deal’ may increase, focusing on long-income, Brexit resilient tenants and structurally driven sectors could provide some shelter to short-term volatility. Furthermore, a possible Soft Brexit or even Remain scenario cannot be fully ruled out.”

james.wallace@realassetmedia.com