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Correction in UK commercial property market ‘unlikely’

2 May 2018

A major correction in the UK commercial property market is unlikely this year thanks to solid fundamentals and a realisation that Brexit will not herald another financial crisis, Kames Capital believes.

Phil Clark, head of Property Investment at Kames, says the market remains in good health despite the ongoing uncertainty over Brexit, with net inflows into the £642m Kames Property Income Fund higher now than they were before the EU referendum.

“Investors’ fear has given way to a realisation that Brexit is about the increased cost of trade that would occur once the UK left the European Union and not another global financial crisis,” he says.

“UK GDP is still fundamentally robust. Yes, there is uncertainty as to the terms of trade we will undertake with Europe post Brexit. But trade with Europe will not cease. Moreover, supply and demand in the market has been in healthy balance for some time because, unusually, in the build-up to the Great Recession there was not excessive development and therefore there was a lack of over-supply once the recession hit.”

With ‘demand constant and no enormous amounts of vacant space’ Clark says the market, while late in the cycle, is unlikely to experience a major correction in the foreseeable future.

“What could cause one?” he asks. “There is no excess credit in the system. UK corporates are cautious about debt and they don’t want to leverage the sector like they did pre-2007. Geopolitical risks like an escalated trade war could spook markets and bring caution into the asset class, slowing transaction volumes – but we think the prospect of that, or something like a Russian cyber-attack on UK infrastructure, is unlikely although there is always a risk however remote.”

With the Bank of England indicating that the scale of rate rises will be less than previous post-recession cycles, Clark says the investing environment will remain supportive, although he points out that future returns will not be driven by strong capital growth.

“Going forward it will all be about income,” he says. “At this point in the cycle our focus is on buying the right properties with the right tenants, or spaces we can re-let if required.”

Clark adds the fund, which has a historic yield of 5.20%*, will continue to have a low exposure to London and industrial properties, both of which have been key drivers of recent returns across the sector.

“There has been an ‘Amazon effect’ with warehouse space but we are not willing to buy the distribution story at a 4% or lower yield,” he says. “At that price everything has to go right to make it worthwhile. We would rather focus on smaller properties which provide greater diversity, proven yield pick-up without high risk, and less distressed pricing than the highest value assets. We always keep a firm eye on how we think assets will perform in all market cycles and at this point the focus must be on careful stock selection, pricing and security of income.”

Kames manages circa £2 billion of direct and indirect property assets.

* Source: Lipper, NAV to NAV, noon prices, as at 31/03/2018. Income reinvested, net of ongoing charges, excluding entry or exit charges.

**Source: Kames Capital as at 31 December 2017.

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