UK real estate should avoid the worst of a recession

COMMENT It is clearly too early to say how long and how deep a global recession might ensue given the effective shutdown of large parts of the global economy. However, in our view the outlook for the commercial property market is not as severe as some are predicting. We know that property, as an illiquid asset class, tends to be much slower to react to economic events than other financial markets. The property market in the UK is also being upheld by key fundamentals, which may mean it will likely avoid the worst of any recession that coronavirus brings. While in the short term rental uncertainty and a reduction in available liquidity in the market will dampen yields and pricing, the market in the long term should rebound, although it is not yet clear when this may occur. Historic trends We can get an indication of how the property market may respond to the current crisis by looking at previous cycles. Looking at historic trends, alternate recessions lead to a major real estate crash, with GDP contractions in between seeing total real estate returns typically remaining positive throughout, with rental income compensating for a gentle pricing correction. The logic for this is that while the memory of the previous crash remains fresh, market discipline maintains leverage and development supply at sustainable levels. If we compare the UK market now to pre-2008, real estate is entering this period of contraction in considerably better shape than before the global crash. LTVs and interest costs are significantly lower, so while the severity of the crisis will lead to price reductions, we would hope not to see a crash on the scale of a decade ago. It could also be argued that in a low interest rate environment there will be a “a dash for yields”, with property centre-stage. In addition, property valuations were at sensible levels going into the crisis. Brexit had dampened UK real estate pricing over a number of months, and the “Boris Bounce” did little to lift the market. Therefore, UK valuations are much less stretched going into this slowdown than other global markets and, indeed, compared with previous market downturns. Past cycles have also shown that UK real estate, due to the fundamentals of transparency and liquidity, reprices faster than other markets. This should present opportunities for investors with capital to invest ahead of market recovery. Supply and demand Going into this crisis, supply and demand dynamics were also well balanced. Supply was constrained and demand was steady across a number of sectors, including offices, and industrial and logistics. Therefore, the temporary fall away in demand during the coronavirus crisis should not spell catastrophe for many asset classes. Indeed, some assets, such as industrial and logistics, are still in high demand during the crisis, with essential retailers and services requiring more space to serve customers in lockdown. Some asset classes will undoubtedly suffer, most obviously retail. However, investors with diversified portfolios should feel confident that they can weather the storm. A flight to quality will also ensure that values for core are supported in the short term. Secondary property is more likely to bear the brunt of negative sentiment, although following the crisis businesses will be protecting cash and will be willing to stick to lower-cost accommodation. Given these market fundamentals, the UK property market was well placed going into this period of uncertainty compared to other markets and previous recessions. Good market discipline combined with sensible valuations and balanced supply and demand mean that UK real estate could avoid the worst of this downturn. Manish Chande is senior partner at Clearbell Capital