M&G favours UK living and retail sectors amid repricing

M&G Real Estate continues to see the property market offering income and growth prospects, despite rising interest rates and investor risk aversion. In its Global Real Estate Outlook 2023 report, M&G warned on rapid asset repricing in the UK which is “hurting” traditional commercial sectors such as offices and logistics. The investor said it expects portfolio allocations to offices and logistics to shrink, with low yields harder to justify against a backdrop of rising bond yields. M&G’s head of property research Richard Gwilliam said: “Office markets are all down on pre-pandemic levels but are seeing a bounceback from the depths of lockdowns and a resurgence in office attendance and occupancy. “Fridays obviously are well down on pre-pandemic levels, probably Mondays as well. But Tuesdays, Wednesdays and Thursdays are generally very busy. “We need to think of those less busy days in a similar way to Saturdays and Sundays, with office occupiers generally paying rent for their occupational needs during any given period, which will include Fridays, Saturdays and Sundays. They need the space for busy days, and they will pay for it.” Looking ahead, M&G expects to see less occupational demand for offices but with a shift towards space that meets occupational requirements. It said employers were already enticing their employees into high-quality amenity-rich spaces with higher ESG and wellbeing credentials. Pressure on logistics Turning to logistics, Gwilliam said: “The sector has benefited rfom significant yield compression over the past decade. That has driven strong growth and strong returns for a very long time. “The sector is now under the most repricing pressure as the yields that have been reached by the early part of this year had just simply become too low.” Gwilliam said repricing has been happening more quickly in the UK than in continental Europe, thanks in part to the turmoil created by the government’s mini-Budget in late September which accelerated the fall in values. “Partly it’s because of what has been happening to interest rates and bonds and therefore the cost of financing for real estate is much higher,” said Gwilliam. “But there’s also liquidity. The UK is one of the world’s most liquid real estate markets and that goes hand in hand with greater transactional evidence and greater volatility.” According to M&G, average capital values from the end of June to the end of October showed a 12% capital decline, with October marking the fastest monthly rate drop on record at almost 7%. M&G said it expects the figures to go “well into double-digit declines” over the course of 2023, with some markets possibly reaching 20% or even more before they bottom. Opportunities in alternatives More positively, M&G’s report indicated that pricing changes may create new investment opportunities, with allocations to alternatives, including residential and student housing, offering relative resilience, underpinned by a chronic supply/demand imbalance. Gwilliam said: “The residential sector in pretty much all markets has been more defensive and more resilient than the commercial sectors. “One of the reasons for that is because of pressures on the housing market, preventing people from buying their own house. But they have still got to live somewhere, so actually that is helping to support the rental side and helps underlying values of invested real estate.” M&G has also favoured retail investments as it the sector has already undergone a significant pricing adjustment, offering more attractive yields and the potential for outperformance in the short term. “The structural change driven by e-tailing and the challenge to bricks-and-mortar retail is clear and everyone’s aware of that,” Gwilliam said. “As a result of those challenges and rental issues, retail yields going into today’s downturn were pretty similar to where they were 10 years ago so it’s proving already to be more resilient.” Jose Pellicer, head of investment strategy at M&G Real Estate, said: “Experience shows that in the years following recession, real estate tends to perform strongly. “There will always be shifts in the nature of the assets making up portfolios in particular markets, but the underlying indicators for renewed performance and growth will remain strong, with real estate continuing to play an important role in multi-asset portfolios.”   To send feedback, e-mail evelina.grecenko@eg.co.uk or tweet @Gre_Eve or @EGPropertyNews Photo © Gerd Altmann/Pixabay