The obvious defining event close to home of 2016 was the UK’s referendum on EU membership. It pushed investors into wait-and-see mode before polling day, and piled on the uncertainty after the vote. That uncertainty is still very much with us.
Away from politics, there was a couple of upside surprises on the economics front. The Eurozone economy looks like it is actually going to grow faster than the USA’s (1.7% compared to 1.6%). This will be the first time that this has happened since 2008. On this side of the channel, not only has the UK economy performed surprisingly well since the referendum, but it is within a whisker of growing faster than the world economy as a whole. That is all interesting economic trivia but the key point is that occupier markets, both in the UK and elsewhere in Europe, were surprisingly strong all things considered.
So what does 2017 have in store? The Eurozone out-growing the USA is often a sign of impending recession (as Europe lags behind the USA in the economic cycle). That does not look to be the case this time. The US economy is looking quite positive for 2017. Europe, by contrast, faces the dual challenge of higher inflation eating into real incomes and the political uncertainty surrounding a number of major General Elections to be held in 2017. Nonetheless, Euro-area growth in 2017 might prove to be surprisingly robust in the face of political uncertainty in 2017, just as UK growth was in 2016. Surveys indicate that the Euro-area economies are ending 2016 on a high, governments are relaxing fiscal policy, if only a little, and dollar appreciation and US growth might enhance export performance. As for the UK economy, talk is still of a referendum-induced slowdown but it is not yet evident in either the official economic data or the survey data both of which continue to surprise on the upside.
My financier colleague has mentioned higher inflation, which is bound to feature in 2017, and what might happen to interest rates, so I will not repeat it, but we cannot get away from another mention of political uncertainty. In stark contrast to 2016, we actually expect a year of no surprises as far as the major European General Elections go. That does not mean that investor behaviour will not be affected. If the opinion polls are showing a close race, investors will be tempted into a “wait and see” attitude just as they were before the UK referendum (assuming, that is, that anyone watches opinion polls anymore!). At least this time around there is scope for a bounce-back if we are right about no surprises.
In the UK, uncertainty about what Brexit means will not go away. However, UK property pricing now seems out of sync with the rest of Europe. There is scope for further price adjustment but at some point the UK will start to look relatively cheap. Furthermore, political uncertainty in other major European markets might even be to the UK’s benefit in the competition for cross regional capital.
After a 2016 best described as “uncertain” what can we expect for 2017? It may be unadventurous to say more of the same but I think that is what we will see.
Politics has been in focus this year, with the EU referendum and change of Prime Minister in the UK coming to the fore. Added to this, a surprising US Presidential Election topped off the year nicely.
The uncertainty that this engendered was illustrated, at least in part, by lower investment volumes in the UK – though it must be said that the liquidity cycle was turning down from mid-2015. In 2017 the focus shifts to Europe with elections in The Netherlands, France and Germany. The UK is not without events, but the expected service of an Article 50 notice will only be surprising if it does not happen.
Policy revisions, and especially the expectations of a more expansionary government in the US, accompanied by rising interest rates, will likely play their part. The UK is expected to ease, slightly, its austerity programme. In Europe, the issue is more whether quantitative easing continues rather than whether governments will seek to promote greater economic activity.
Against this background, while talk of the end of the US economic cycle seems to have been replaced by talk of a new upswing, expectations in the UK and Europe are of continued unspectacular growth – much in line with a long, low cycle often discussed by Neil and myself.
These changes in economic policy and rising inflation expectations are pointing to rising interest rates, but these seem to me to be more of a US phenomenon than a European one. I note that recent rises in European term rates have only seen a return to pre-referendum levels (rather than what was considered normal prior to the GFC) and the forward yield curve remains very flat.
I expect the dispersion trade, which was the underlying theme of UK price movements, and activity, during 2016, to continue. Prime, with the definition, very focused on income stability, will continue to find favour for yield hungry investors. Price discovery will continue in more secondary and value add situations, providing evidence of falling prices but probably really crystallising what has already happened but remains hard to see. This price discovery should lead to an uptick in volumes in less bright and shiny assets. The more secular trends of undersupply in fit for purpose logistics and oversupply in retail will continue to work through. Other situations will be more finely balanced with the supply/demand equation in London offices a case in point.
In terms of UK opportunities, development funding in the form of debt is very hard to come by but is generating very interesting returns for those who can provide it, often ‘real’ money investors. We are also seeing returning interest in senior debt as a real estate asset class as investors are less willing to account for growth in their returns projections and are more concerned about the risks of future price weakness.
Looking at capital flows, a reflating US may prove to be a magnet for both domestic and international capital sources. For non-dollar allocations the recent very strong performance in continental Europe, combined with some price weakness in the UK, exacerbated by FX effects, and the more continental focus for political instability in 2017, may see the relative attractions of the UK and the continent swing back towards the UK.