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UK (London) Investment Strategy – not yet but soon?

Having stuck to its core principle of investing in ‘Themes’, SW3 successfully deployed capital in the Dublin Real Estate market through a number of dedicated Funds from 2013 onwards. In line with its philosophy, the company co-invested in all of these Funds and has recently commenced the disposal phase of its initial investments in Ireland. Based on the most recent valuations, all strategies have outperformed their target return profiles to date.

Having recently assessed a number of other European geographies, we are now turning our attention to the UK and will be looking to continue delivering outsized returns for investors. This may seem an obscure objective at the present time with yields being close to record lows and capital values and rents at record highs but with London being the most liquid and transparent market, one must be ready to act when the cycle turns and deploy capital efficiently.

Unlike other less liquid markets and based on historical analysis, the window of opportunity can be as short as 6-12-months. Taking into account the time required to raise and deploy capital, it is vital to be ahead of the game in order to avoid “joining the crowd” when the market turns and hits an uptick leaving significant value behind. We are therefore spending time designing the appropriate strategy and securing capital now for deployment at a later date.

Each of our previous themes are unique and diversified: “How to Capture Real Returns in the Property Market”, “Ireland – Time to Analyse the Fundamentals”, “Asia – Getting on the back of the Tiger” and “Ireland – Building on the Fundamentals”. Similarly, our latest London focused theme presents its own unique characteristics.

We don’t try to predict what may cause a change in the current environment as it could be a number of different factors from risk free premiums being pushed out as inflation expectations take hold, a hard Brexit, government policy changes, a global stock market correction or geopolitical risks. The reality is that a combination of factors will create a re-pricing of assets, making the current pricing of Real Estate look out of sync when compared to other asset classes. The outcome will be a re-allocation of pricing, both occupationally and in capital markets.

What we are looking for: 

London centric correction in Real Estate offering opportunities to buy at, or below, the long-term average….

SW3 continues to selectively invest in Dublin and although the market has seen a strong recovery, we believe that it remains the best location for European investment due to its unique macro and micro fundamental drivers, not seen elsewhere at the present time. As such, any new UK strategy will solely focus on the Greater London Area. We firmly believe that Dublin offers more liquidity and better occupational demand than the UK regions and as such we anticipate Dublin to act as an amplifier to any potential UK regional growth while at the same time being more closely linked to overall European major city investment performance.

Therefore, any UK strategy will be focused on investing in London centric assets when the market reverts to or below its long-term average rather than a bet on overall “UK PLC” as the regional markets are more exposed to the upward and downward swings in the prospects of UK GPD which is broadly poor in the short and medium term. Focusing on London rather than regional opportunities offers protection in cyclical corrections and given our conservative investment ideology, capital preservation is always paramount to our analysis.

London Focus

We have used historical City of London data to measure optimal timing for new investment into the London market, as it is the most transparent, largest and liquid market. Our analysis of this market subset concludes that it is the most accurate source of data so is useful for illustrating our thinking. It is possible to transpose this data across all asset classes and all sub-markets in the Greater London Area with specific variable changes and the produce similar results.

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The City of London office market has been trading above its long-term average for the past seven years but the trend has been exceptionally pronounced over the most recent four years. When analysing rents, capital values and yields, the market looks 40-50% more expensive than long term average since 2000.

There is a well established view that looking at the long-term average is not suitable in the “new normal” of lower rates for longer, coupled with the demographic changes in the Western Economies lowering the “Natural Rate” meaning that rates of the past aren’t suitable for todays market. This is true in part but also used by Central Banks to justify their swollen balance sheets and maintaining accommodative rates to keep GDP growth ticking over.

However, with the return of inflation (albeit relatively low) in the United States and the Fed’s path of adjusting interest rates slowly higher, we believe the UK/European market is twelve to eighteen months behind and will see the rates market push wider during 2018. The premium required by investors for Real Assets will move outwards accordingly. This will have an impact in financial markets (price of debt), investment markets (yields) and occupationally (tenants ability to pay historically higher rents). As London markets are comparatively expensive in a global context any small movement in pricing expectations could have an amplified effect on real assets.

We don’t envisage a full scale blow out similar to 2008 in the short term, as financial markets are currently inherently safer but we do anticipate a correction in pricing which will result in opportunity for acquisitions in a two-phase process.

Firstly, ‘Core’ assets at heightened levels of stress and secondly, ‘Core Plus’ assets once the occupational market re-sets and starts a new cycle. Therefore, we are advocating acquisitions when yields/capital values are +/- 10% from the long-term average in London and with good asset selection, strong returns over a medium term investment horizon are achievable.