Column: An approaching ‘new normal’ in financial markets heralds an era of stability for property

By Walter Boettcher - Friday, March 09, 2018 9:48

Increasingly, the UK property market looks to have matured further with a wider range of assets and geographies elevated to the status of ‘safe haven, writes Walter Boettcher, chief economist at Colliers International.

At least four factors fundamentally impact property pricing and investment: economic performance; capital availability; fund allocations to property and the financial environment. While the former three are stable and positive, the latter is undergoing a sea change with bond yields seeming to turn a corner on a 36-year bull market.

Since the early teens, bond yield compression has supported asset prices globally across all classes including equities and real estate. With base rates, debt costs and government bond yields rising over the next five years, property investment returns will undergo transition to a ‘new normal’ which will be more subdued and less volatile. This is evident already.

The new normal will be more benign than the old pre-financial crisis normal.

Oxford Economics has forecast that US 10 year treasuries will peak at 3.5% in 2022, at 4% for 10 year gilts in the UK in 2023 and at 3.8% for 10 year bunds in 2030 in the Eurozone. Hence the new normal in the UK and the US is likely to arrive in the early 2020s.

In the UK, the transition to the new environment will be accompanied by stable, single digit total returns averaging around 4.8% pa reflecting very modest rental growth of 1.1% pa and capital value growth of -0.1% pa according to IPF Consensus Forecast to 2023. Property yields will remain stable despite rising bond yields. This is the result of adequate ‘headroom’ with a large yield gap that could absorb at least 150bps of bond yield expansion.

Furthermore, the global shortage of ‘safe haven’ assets, while tempering bond yield rises, will also temper any outward yield shift for prime real estate assets in Central London and other gateway cities, including the UK regional growth cities. Uniquely, the UK will also continue to benefit from the ongoing arbitrage of an undervalued currency (10% below long-term equilibrium level) until the terms of any political settlement with the EU is clear and implementation has begun.

This stable UK investment profile, while not offering as high a return as the earlier phases of the bull market will ensure that steady bond-like returns will be supplemented by low volatility and lower perceived risk. Increasingly, due to a permanent increase investment liquidity, the UK property market looks to have matured further with a wider range of assets and geographies elevated to the status of ‘safe haven’. This will be of great appeal to both domestic and foreign institutional investors, all of whom are continuing to increase fund allocations to real estate globally.

Walter Boettcher, chief economist at Colliers International

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