Overseas net investment to ease
By Roxanne James

The Key Risks to British Real Estate in 2016

According to research from insurance giants Aviva, Brexit, euro-zone debt and UK interest rate rises will remain the downside risks for UK real estate in 2016.

Richard Levis, global real estate analyst at Aviva suggests that the impending vote on EU membership is one of several risks that could affect UK real estate returns this year. "We expect healthy occupier demand and a broader recovery in the rental market to drive capital appreciation in coming months. Good quality, higher-yielding assets are likely to do especially well this year, but there are multiple risk factors that could have both negative and positive implications for the market," he said.

"We doubt the UK electorate will vote to leave the EU this year. However, short of a decisive mandate to remain in the EU, the aftermath of the vote could see unusually high currency volatility, higher gilt yields, capital flight, weaker economic growth and another Scottish referendum. All of this could drain liquidity and damage investment performance of UK real estate in the short-term," he added.

"Even in the event of Brexit, the UK will probably retain extremely close economic and political ties with the EU. Hence, longer-term impact would depend on the outcome of trade negotiations between the two parties. A UK exit would put the central London office market most at risk within the commercial occupier sector. London's financial district is especially vulnerable due to a potential drop in demand for buildings from the financial services industry".

The general view is that UK interest rates should remain low in 2016, rising at a gentle pace throughout the coming years, parking below pre-2008 historic norms. However, rapid and unexpected policy tightening could damage real estate returns if property yields also increase rapidly.

Rental growth in UK real estate is currently at levels not seen since the last cyclical peak. Analysts expect price growth to cool this year as the central London office market slows. However, there is a possibility rents will surge on restrained supply, low vacancy rates, a lack of new development and steady economic expansion. The biggest upside potential is in the industrial sector, which has not had much real term rental growth since the late 1990s.

"This year we expect overseas net investment to ease amid slowing emerging economies, heightened geopolitical tensions and low oil prices. But we can also envisage an upside scenario where overseas net-investment continues to rise and, as a result, yields for the best quality assets would fall further. In addition, demand for lower quality secondary assets and strategies would rise fuelling a further "re-rating" of secondary yields. This scenario would also put further pressure on investors to increase exposure to non-core real estate assets such as infrastructure, residential, healthcare, care homes and leisure," adds Levis.

With the landscape changing in the UK, investors are expected to diversify further within the asset class of commercial real estate. With increasing opportunities for retail investors to enter commercial property markets through crowd-funding platforms and real estate investment trusts (REITs), the sector is expected to experience significant growth in coming years.

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