What investors fleeing UK properties are getting wrong

20 Fenchurch Street, also known as the “Walkie-Talkie,” left and Leadenhall building, also known as the “Cheesegrater,” center, are among high profile properties owned by UK

Yields on UK property are “historically compelling”

By Sara Sjolin/ Market Watch

Think the UK property market is one of the worst places to invest after Brexit? Think again, it’s actually one of the most attractive propositions for yield-hungry investors in an ultralow interest-rate world. While the UK’s shock EU referendum result sparked grave concerns about British real estate, it also cemented expectations that interest rates are going to stay lower for much longer. That means there’s very little yield to be had—and in some cases even negative yields—on government bonds, making potential returns on property attractive. The spread, or difference, between UK yields and real estate is now around a record high and set to widen even further, according to analysts. instruments and property yields is about 600 basis points, and in some cases closer to 650 points,” said Andrew Angeli, head of UK research CBRE Global Investors, a real-estate investment management with $31.8 billion of assets in Europe, the Middle East and Africa. “It’s certainly one of the reasons we’re still positive on the asset class,” he added. “It’s historically compelling.”

Financial markets were roiled after the Brexit vote on June 23, with stock markets slumping, the pound tumbling to a 31-year low and yields on government bonds several places sinking to all-time lows. The interest rate on 10-year gilts TMBMKGB-10Y, +0.00%  dropped to a record low of 0.746% on July 8, according to Tradeweb, while yields on benchmark government paper in Japan and Germany sank deeper into negative territory.

“While uncertainty means volatility is likely to remain, fundamentally we feel the REITs are better positioned than the market credits and have been disproportionately punished,” – said UBS stock analysts.

The panic also sparked fears that UK property would be hit hard on concerns the vote would increase unemployment, hamper business activity, slow foreign investment and prompt some companies to move elsewhere. Several UK commercial property funds froze withdrawals in a bid to avoid a fire sale in the real-estate market, while shares of housebuilders and UK real estate investment trusts, REITs, tumbled more than 30% in some cases. While uncertainty means volatility is likely to remain, fundamentally we feel the REITs are better positioned than the market credits and have been disproportionately punished,” UBS equity analysts said in a note earlier in July.

Since their assessment, the UK property stocks have recovered some of their Brexit-fuelled losses, but it doesn’t change their overall investment case for REITs, which is one of the easiest ways for retail investors to gain exposure to real estate. REITs are also attractive because they offer stable dividends derived from rental income.

The UBS analysts said the sector can weather a downturn as there are a number of factors that work as a buffer if the market sours:

  1. Appetite for yield –UBS thinks low rates across much of the globe will continue to support a bid for real estate, with implied yields of 5.5%.
  2. Stable assets –The properties that tend to comprise a REIT boast relative long leases that average seven to 10 years, and the buildings usually have low vacancy rates. This secures a stable rental income.
  3. Rational construction –House builders are likely to shelve some of their projects, which should offset a potential slowdown in demand.

Construction on new UK property is set to slow down after Brexit as concerns about the real-estate market linger

UBS maintains buy ratings on British Land Company PLC BLND, +1.28%, Derwent London PLC DLN, +1.17%, Great Portland Estates PLC GPOR, +1.79%, Hammerson PLC HMSO, +1.18%  and Land Securities Group PLC LAND, +0.46% .

Another argument for staying upbeat on property investments is the outlook for another rate cut at the Bank of England. Gov. Mark Carney & Co. refrained from lowering rates at their July meeting, but hinted that more easing would come in August. Expectations for a rate cut have increased since the July 14 meeting after some lacklustre data and dovish comments from policy makers. “There probably will be a rate cut next month, possibly further QE, and that would suggest downward pressure on UK gilts,” said Angeli from CBRE. “In terms of property pricing, it’s fair to say that we’ll probably see yields begin to drift [higher]. We have some anecdotal evidence of that already occurring so that would suggest the spread is actually widening further,” he added. Real estate yields go up when prices for the underlying property fall, which are expected to happen in the aftermath of Brexit.

Risk factors: There are caveats, though, when considering betting on UK real estate. Hani Redha, portfolio manager for multi asset investment at PineBridge, warned against buying into commercial real-estate funds, such as the ones that were gated after the Brexit vote, as they don’t offer the kind of liquidity retail investors usually expect. One of the big issues with those funds was that they were offering daily liquidity, but with underlying assets that are highly illiquid. When there’s a rush for the exit, there’s not enough cash on hand to meet the redemptions, forcing these funds to freeze trading.

Additionally, Redha warned that REITs, which are traded like a stock and do offer daily liquidity, are just as sensitive to the stock-market moves as to the property market. “You’re not getting the direct benefit and at the same time you’ll pick up a lot of volatility because of the equity markets, which will continue to be under pressure for some time,” he said.