Relativity, stability, and can I really be ten years older?

23 May 2017

As I scribbled down the date from last week’s KFIM investment committee, I found myself reflecting on the number “7” in 2017; can I really have aged 10 years since the Global Financial Crisis (GFC) first emerged?! I am not sure quite where the time has gone, but regardless of whether the start was Northern Rock, Bear Sterns or Lehman’s, it was certainly a long time ago.

A scarcely believable (and totally unexpected) result of the GFC, is that the Bank of England base rate has now been below 0.5% for over eight years (since March 2009). It does not matter how you look at this, it is an improbably long period for what can only be called “improbably low interest rates”.

So where are we today? Since the GFC occurred, all markets, including property, have reset themselves in terms of cap rates. Our view is that property yields are close to some sort of equilibrium and we do not expect them to move much in the short to medium term; subject of course to interest rates remaining stable (which is what consensus forecasts currently indicate). Clearly a change in the outlook for growth could well lead to a shift in yields, but here too the markets continue to look stable; our expectation for rental growth over the next couple of years is in a range of between -1% and +2% p.a. but this is not really enough to shift yields decisively.

As far as investment performance is concerned, returns in the short to medium term will be heavily dependent on the income return; which currently stands at around 5.25% depending on which index you refer to. Add on a little active management, a small amount of reversionary potential, good stock selection (there will be winners and losers) and you should get to 6% (which just happens to be our forecast for 2017).

But is this enough to retain the interest of investors, particularly bearing in mind that 6% is fairly modest compared to the returns of recent years? In reality of course, we need to be thinking about relative returns rather than absolute figures. It is important to distinguish between prospective returns relative to what has gone before (which will not be so good) and returns relative to everything else (which should be much better). Investors should be making decisions based on the options available today (not those available yesterday) and with debt being both cheap and relatively freely available, and bond yields remaining at historically low levels, we suspect that even with the prospect of a return of 5 to 6% (ungeared), property looks pretty good value compared to the other investment alternatives.

Ian Whittock

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