Notice to investors in Australia. M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission of the Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws.

February 2019

UK Real Estate Market Outlook For Investment Professionals only

REAL ESTATE

• Healthy economic activity underpinned by consumer sector and ongoing labour market strength

• Brexit uncertainty continues as UK government mulls over UK-EU deal

• Structural change continues to boost the industrial sector

• Flexible office space providers advancing regional take-up

• We believe ‘Destination’ retail well placed to weather the current turbulence

• Demand, diversification and defensiveness: Alternatives continue to appeal to investors

Executive summary

02

Inflation has also continued to edge downwards, having peaked at around 3% at the end of 2017. Now broadly in line with the Bank of England’s target, at 2.1% (December 2018), price pressures are expected to ease further in the short term. This should ensure that the path towards interest rate normalisation remains slow and steady. There is, however, significant uncertainty surrounding both expected price growth and any ensuing interest rate movements in the face of Brexit.

Overall, the UK economy looks to be in relatively good shape, with any weakness largely attributable to the uncertainty caused by the Brexit negotiations. If a Brexit deal is agreed, greater clarity around the future UK-EU relationship and a move towards the transition period should help to unlock some of the current economic standstill, particularly in terms of investment, boosting short term GDP growth.

Brexit uncertainty continues

The end of Autumn saw some progress made by Theresa May and her government on the road to Brexit, with the approval by EU leaders of a Withdrawal Agreement and a draft Political Declaration focusing on future UK-EU relations. However, Parliament voted against the deal and, at the time of writing, negotiations relating to the future path of Brexit were still ongoing in the House of Commons.

With the initial proposals rejected, what seemed like a fairly simplistic ‘Deal or No Deal’ situation has instead become a wider range of options, from a renegotiated Deal to delaying the date we leave the EU or even to the possibility of a second Referendum. What has become clear though is that the majority of MPs on both sides of the political divide are against a No Deal scenario. This will hopefully lead to increased co-operation and therefore a solution to the current stand-off.

If negotiations do succeed, this would likely be positive for economic stability. The consensus view is that the adoption of a deal will lead to stronger short term economic growth, as investment and spending decisions that had previously been put on hold are put into action.

The UK economy: continued resilience in the face of ongoing uncertainty

While the headlines have been dominated by doom and gloom stories relating to the UK-EU Brexit negotiations over the past six months, the UK economy itself has proven to be remarkably resilient, growing by 0.6% in the third quarter; its fastest pace of growth for almost two years.

Figure 1: Third quarter bounce back in GDP growth

Source: ONS, November 2018.

The labour market remains strong, with employment still at a record high and unemployment close to a 45-year low. With joblessness at a very low level, employers are finding it increasingly difficult to fill positions so the number of job vacancies is at its highest since records began in 2001. This is starting to feed through into pressures on earnings. As a result, wages are rising by 3.2% pa, the highest rate of growth since late 2008. Wages are also rising in real terms – something that will help to underpin consumer spending and consumer confidence levels.

Figure 2: Job vacancies hit new high

Source: ONS, November 2018.

GD

P G

row

th (%

)

2

4

0

-2

-4

-6

-8

Quarter-on-quarter growth Year-on-year growth

Q32008

Q32009

Q32010

Q32011

Q32012

Q32013

Q32014

Q32015

Q32016

Q32017

Q32018

Job

vaca

ncie

s (00

0s)

800

900

700

600

500

400

300Apr-Jun

2001Apr-Jun

2004Apr-Jun

2007Apr-Jun

2010Apr-Jun

2013Apr-Jun

2016Aug-Oct

2018

03

■ ■

Brexit, what Brexit? Property fundamentals continue to underpin performance

The UK property market has continued its cyclical slowdown in recent months, with total returns now in the single digits (MSCI All Property 7.5% pa, December 2018) and likely to ease further in the next few months. In large part this reflects the shift from yield compression being the main driver of performance to income return accounting for the bulk of total returns.

While more muted economic growth and Brexit uncertainty is driving part of this deceleration in aggregate, looking beyond the All Property average indicates that sector-specific fundamentals are leading to very different stories being played out across the different markets.

Figure 3: Long term demand shifts driving short term performance

Source: MSCI, December 2018.

Long term trends are driving current performance, with the industrial sector still seeing the strongest performance, backed by ongoing structural change. Meanwhile Alternative sectors (such as residential, hotels, healthcare and leisure) are also outperforming, underpinned by factors such as demographic change. In contrast, retail, where future rental fundamentals appear more challenging, continues to weaken on average.

MSC

I tot

al re

turn

s (%

pa)

25

30

20

15

10

5

-5

0

Retail Office Industrial Residential Hotel Other

Dec2013

Dec2014

Jun2014

Jun2015

Jun2016

Jun2017

Dec2015

Dec2016

Jun2018

Dec2017

Dec2018

Retail polarisation continues

With retailer retrenchment ongoing and CVA*s grabbing the headlines, occupier demand and rental growth remain weak. Average rents are now falling across the various retail types, exacerbated by the fact that there are now twice as many stores opening as closing. Undeniably, the current retail story is one of adversity, yet it is important to note that some parts of the market are more future-proofed than others.

Figure 4: Retailers drawn to quality, not quantity

Source: PMA, November 2018.

The retail story is increasingly one of divergence and polarisation. Quality remains a major factor in terms of occupier demand and thus rental performance, with prime retail generally holding up better in terms of vacancy, while more average property is suffering to a greater extent. In addition, locations with supportive demographics, that are well located and accessible with ‘destination’ appeal, are likely to better weather the current turbulence in the retail sector. Likewise, retail parks close to good transport routes that can use click and collect to attract customers are also positioned for future success.

Town Centre Vacant Units (%)

Town Centre PrimeVacant Units (%)

-5 0 5 10 15 20

All Major Cities' AverageAll Regional Centres' Average

NottinghamCardiff

LeedsBirmingham

ReadingBristol

ManchesterOxfordDerby

GlasgowSouthampton

BathLiverpool

CambridgeBrighton

YorkGuildford

Kingston-upon-ThamesCity of London

EdinburghCanterbury

Bond Street

*Company Voluntary Arrangement

04

----■ ■

■ ■ ■ ■ ■ ■

Industrial: addressing the supply/demand imbalance

The industrial occupier market continues to thrive, with rental growth at 1.1% on a three-month basis (MSCI, December 2018). The expansion of logistics and distribution networks, driven by structural change, shows no sign of abating and even retailers that are otherwise reducing their retail footprint continue to invest in industrial units. From a demand perspective, therefore, conditions seem little changed.

It is instead on the supply side that things are starting to alter. Increasingly, we see signs of a wave of speculative development, albeit focused on Big Boxes rather than multi-lets. This has taken volumes of speculative space under construction to post-Global Financial Crisis highs. Much speculative space is being focused at the larger end of the market, yet demand is focused on smaller units in London and the South East, which means there is a growing threat of a future supply/demand mismatch within the sector.

Figure 5: Big box speculative starts trending upwards

Source: PMA, Q3 2018.

Rolli

ng a

nnua

l spe

cula

tive

star

ts (m

illio

ns sq

ft)

10,000

12,000

14,000

8,000

6,000

4,000

2,000

0

Standard Industrials (<100k sq ft) Big Box Logistics (>100k sq ft)

Q12000

Q12010

Q12008

Q12006

Q12004

Q12002

Q12012

Q12014

Q12016

Q12018

Ongoing resilience in the London office market

Despite the uncertainty that has surrounded the Brexit negotiations so far this year, the central London office market has proven to be remarkably resilient. While we have seen some softness in rents, this has been relatively limited, with both prime and secondary rents now stabilising. However rents could still face some downwards pressure over the next 12-24 months as more space comes onto the market. This is likely to be relatively muted, particularly when compared with previous construction booms.

Figure 6: Central London rents have only seen limited decline

Source: CBRE, January 2019.

Diversified occupier base supports regional offices

Already a significant trend in the London market, flexible office space providers are fast becoming an increasing driver behind take-up in the regions, alongside the government. At the same time, the supply of Grade A space in particular remains relatively restricted given the limited amount of stock in the pipeline. Further office space is also being removed from the market by office-to-residential conversions. This combination of restricted supply and healthy demand is likely to ensure that rental growth remains relatively resilient despite economic headwinds.

Rent

al g

row

th (%

pa)

15

10

5

-0

-5

-10

Prime Secondary

Dec2010

Dec2011

Dec2012

Dec2013

Dec2014

Dec2015

Dec2016

Dec2017

Dec2018

05

■ ■

■ ■

Geographic polarisation a key feature of the PRS market

The Private Rented Sector continues to be polarised by location. Brexit uncertainty and ongoing development have continued to restrain rents in the central London market. The rest of London is proving more resilient, although larger supply pipelines have affected rental levels in specific micro-locations. Nevertheless, overall tenant demand has continued to improve, while corresponding rental supply reduces. This will act to underpin rents, although affordability concerns may temper the pace of growth in the short term.

Figure 7: London shows signs of stabilisation

Source: ONS, December 2018.

Stronger growth is being seen elsewhere in the country, notably in major urban centres that are suffering to a lesser degree from the uncertainty. These markets have not seen the same supply response that is underway in London and, from the demand side, are less exposed to the results of the Brexit discussions. That said, with increased interest from investors in moving into Build to Rent in the regional markets, there is a risk that some cities will see significant levels of development in the next few years. This could temper rental growth in some locations in the medium term.

Inde

x of

Priv

ate

Hou

sing

Rent

al P

rices

(% p

a)

4

5

3

2

1

0

-1

London South East GB excluding London

Dec2013

Dec2014

Dec2015

Dec2016

Dec2017

Jun2014

Jun2015

Jun2016

Jun2017

Jun2018

Dec2018

Sector stories lead investment volumes

Investment volumes remained relatively muted in the third quarter of the year at £16.1 billion, according to PropertyData. Transaction activity was very much in line with structural themes: retail comprised only 8% of overall volumes – a 9-year low – in large part due to the weakness of shopping centres. Meanwhile, Alternative and mixed-sector deals took up an increased percentage of volumes. Alternatives remain very popular, with PRS volumes in particular at record highs of £1.8 billion in the third quarter (according to research by Lambert Smith Hampton), although student accommodation, leisure and hotels are also seeing increased interest.

Perhaps surprisingly given the division caused by Brexit, UK property acquisitions by European investors also reached very high levels in Q2 and Q3 (although activity was more muted in Q4). This suggests that our EU neighbours are not deterred by political and economic concerns and rather continue to believe in the UK as an attractive market with strong long term fundamentals.

Figure 8: European investors show confidence in the UK market

Source: PropertyData, December 2018.

The strong acquisition activity by European investors has been fairly broad-based in terms of investor domicile but the main driver of transaction activity has been purchases in the office sector and, more specifically, in the central London office sector. Again, this is perhaps counterintuitive given that Brexit is likely to affect the London office market to the greatest extent. However, it demonstrates the liquidity and fundamental attractiveness of London in a global context.

Inve

stm

ent v

olum

es (£

m)

3,000

3,500

2,500

2,000

1,500

1,000

500

0

German Irish Other European

2000Q3

2002Q3

2004Q3

2006Q3

2008Q3

2010Q3

2012Q3

2014Q3

2016Q3

2018Q3

06

■ ■ ■

- - ~

I 1 ~ .. II i ~urr ... ..

■ ■ ■

Continued push towards the Alternative’s Alternatives

Real estate is often known as an Alternative sector in a multi-asset context. Within that, real estate’s own Alternatives, namely sectors such as the PRS, student accommodation, hotels, healthcare etc. are continuing to rise in popularity and importance.

Ultimately, what most Alternatives tend to have in common is that the differing drivers versus the traditional sectors enable them to be used as portfolio diversifiers while demonstrating their own attractive underlying fundamentals. The emergence of Alternatives is particularly auspicious given today’s backdrop of significant economic and political uncertainty; it is becoming increasingly important to look for those areas of the market which offer strong, long term growth potential. The tendency for many of these sectors to show defensive qualities can also prove highly beneficial in the current environment.

Figure 9: Diversification potential: Alternatives show lower correlation with mainstream sectors

Source: MSCI, PMA, M&G Real Estate. December 2018 [Correlations are for 20 years, except for Healthcare (11 years) and student housing (13 years)].

Correlation with All Property Weighted average correlation

0.00

0.20

0.40

0.60

0.80

1.00Healthcare

Student Housing

Residential(market lets)

Hotels

Leisure

Retail

Office

Industrial

With such a strong argument for looking away from the standard property segments into Alternative markets, it is no surprise that they are gaining in interest and we believe that this interest will only grow in the future. In aggregate, Alternatives already make up 18% of MSCI’s Investment Universe – only slightly behind the industrial sector (19%). This percentage has more than doubled in just 10 years. With the growth of these markets set to continue, the question should no longer be “should I invest” but “how can I invest” in Alternatives.

Figure 10: Alternatives comprise increasing proportion of Investment Universe

Source: MSCI Annual Digest 2017.

Capi

tal v

alue

(£m

)

Alternatives as % of All Property

200,000

250,000

150,000

100,000

50,000

0

20

16

12

8

4

0

Retail Office IndustrialLeisure Healthcare HotelsResidential Rest of Other Alternatives as

a % All Property

1981 20171985 1989 1993 1997 2001 2005 2009 2013

07

------------·······················

■ ■ ■

,..,,,- ..... __ .,,

■ ■ ■

, ~

,r.. / ~ / I

,.. __ ..,,.,,,,,..--,"' ,,

Ongoing shift to renting drives real estate opportunities

Private renting is becoming an increasingly prominent tenure type, attracting growing institutional investment. This investor interest is backed up by strong underlying fundamentals, both on the demand and supply side:

• The UK population is set to continue growing over the long term with the fastest growth likely to be seen in major urban centres, driving the overall demand for housing

• The rising demand for housing has put upwards pressure on prices in recent years, stretching affordability and encouraging more people into the Private Rented Sector

• The supply of new housing has been lagging the increase in demand, with this supply/demand imbalance particularly severe in larger towns and cities

• The rental market remains small and fragmented, with significant poor quality supply, presenting the opportunity for the provision of professionally-managed, high quality stock

Figure 11: The PRS – a large and growing tenure

Source: English Housing Survey 2016/17.

The supply/demand imbalance suggests the potential for long term growth, not only in terms of house prices but also in terms of rents. However, the PRS also tends to show defensive characteristics, with rents and capital values tending to hold up better than the mainstream sectors’ during downturns, partly reflecting the asset type’s main function as a home, rather than an investment. Each of these factors support the continued growth of the sector as an investment type.

Num

ber o

f hou

seho

lds (

000s

)

% of overall tenure

5,000

4,000

3,000

2,000

1,000

23

13

15

17

19

21

11

9

7

5

No. households % of households

1981 1985 1989 1993 1997 2001 2005 2008-2009

2012-2013

2016-2017

Student accommodation goes from strength to strength

Akin with the PRS, the student housing sector offers an opportunity in the form of a supply/demand imbalance that underpins strong expected rental growth:

• A large and sustainable pool of demand for tertiary education

• A significant number of globally top ranking universities, leading to growing demand from overseas (particularly non-EU) students

• A structurally undersupplied market, with 1.9 students per bed in the UK’s top 20 university cities (according to GVA Grimley), and nearer 3 per bed for London

• A tightening in planning policy, particularly in London, as increasing housing supply takes priority, meaning that undersupply is likely to be exacerbated in the future

Figure 12: Student numbers have been rising

Source: UCAS, December 2018.

Tertiary education also tends to be counter-cyclical, with demand generally rising during economic downturns, indicating defensive potential. The combination of healthy demand, restricted supply and defensiveness suggests that investor demand for student accommodation is only likely to grow in the future. However, the underlying nature of the demand for beds is now changing (eg, increasing demand from international students; the focus on top-tier universities at the expense of the bottom-tier) and it is vital to have an in-depth understanding of the sector to be able to outperform.

Num

ber o

f app

lican

t acc

epta

nces

by

dom

icile

200,000

500,000

100,000

400,000

300,000

0

UK EU (ex-UK) International

2007 20162008 2009 2010 2011 2012 2013 2014 2015

08

-}- -----::= - ~- - - - ---

■ ■ ■

■ ■

Changing lifestyles and demand for ‘experiences’ to support hotel sector

While focused around the concept of bed spaces, like the PRS and student accommodation, the long term drivers of the hotel sector are quite different:

• Consumers are spending a growing proportion of their incomes on ‘experiences’, including travel

• Significant growth in the aspirational emerging market middle class, especially China

• Varying sources of demand (domestic vs. overseas; business vs. leisure), which bring a defensive element to the sector

• Travel becoming increasingly accessible as connectivity progresses, making it easier to cross borders and encouraging visitation for a variety of purposes

Figure 13: Revenue per available room (revpar) compares favourably with inflation

Source: PMA, Autumn 2018.

From an investor’s perspective, in addition to the attractive demand profile, the hotel sector offers the opportunity to access a long (20+ years), index-linked income stream, often backed by a strong covenant, making the investment highly defensive. Given the continued demand for this kind of lease in light of current uncertainty, it is likely that hotels will attract further investor interest going forward. The sector’s compelling macro demand drivers are supporting sustainability (and growth potential) of income. This underpins investor demand for other types of hotel agreement which offer higher income (such as management contracts) in compensation for higher operational risk.

Gro

wth

(%),

perio

d to

201

7

1.5

4.0

1.0

0.5

3.5

3.0

2.5

2.0

0

London Hotel RevPar CPI

5 year 10 year 15 year 20 year

Demographic change driving rising demand for healthcare

Investor demand for healthcare has been growing in recent years, albeit at a lesser rate than for other Alternatives, mainly driven by investors seeking a long, RPI-linked income stream with a strong tenant covenant. The sector is again one of the ‘living’ sectors, and shows very attractive long term fundamentals:

• The demand for both primary (GPs surgeries etc.) and secondary healthcare (eg, care homes) is strongly intertwined with demographic trends, with population growth and ageing expected to underpin both sectors in the long term

• Lack of supply, particularly of modern, fit-for-purpose stock (generally true for both types of healthcare), with significant levels of existing stock seen to be unfit for purpose and obsolete

Figure 14: Ageing population requires greater levels of healthcare

Source: ONS, November 2018.

Healthcare investment tends to be very defensive, being largely a-cyclical (although care homes do share links to the cyclical housing market). The sector typically has a high tenant retention rate and limited vacancy which, when aligned with the lease structure, makes healthcare very attractive. Significant risks do currently exist relating to staff costs, potential over-renting and future NHS funding, however. This indicates the requirement for a thorough and deep understanding of how and where to invest into the sector.

UK

popu

latio

n (0

00s)

85+ as % total population

70,000

80,000

60,000

40,000

50,000

30,000

20,000

10,000

0

6

5

4

3

2

1

0

under 15 15 to 64 65 to 7475 to 84 85 and over 85+ as % total

2018 2028 2038 2048

09

■ ■ ■ ■

■ ■

■

Risk assets – taking advantage of uncertainty

Uncertainty has been the UK’s watchword since the EU Referendum in 2016. Inevitably, any period of uncertainty fuels increased caution but it also tends to lead to investors being overcautious and mispricing assets. This provides significant opportunities for those investors who are willing to take a more long term view and, to an extent, look past short term disruption by starting to take on more risk.

Of course, the word ‘risk’ can cover a wide spectrum of assets, from a slightly off-pitch asset in a strong location to an asset in need of significant repositioning in a weaker town. Given the current headwinds facing both the UK’s economy and property markets, we believe that any risk taken on should remain relatively measured, for example targeting assets that can be repositioned in strong core locations with supply/demand imbalances.

However, when considering moving up the risk curve it is vital that investors are truly able to identify mispriced assets. With so much structural change ongoing in the property market that is completely separate from the Brexit-related caution, strong local market knowledge and proven asset management skills are fundamental to any core plus or value add strategy.

Think long term

• Consider taking on measured risk as we begin to see greater clarity around Brexit

• Look at opportunities in core markets with redevelopment potential

• Start thinking about moving into central London offices once supply and demand are more in balance

Future-proof portfolios

• Take advantage of the potential for long term growth offered by the PRS sector

• Embrace the consumer focus on ‘experiences’ by considering hotels and leisure

• Ensure that portfolios are balanced and diversified across mainstream and Alternative sectors

Benefit from structural change

• Tilt retail portfolios towards assets in well-located ‘destination’ centres with supportive demographics or assets that can benefit from click and collect

• Look to buy industrial buildings located close to urban areas to take advantage of structural change

• Start repositioning office assets to capture the demand from changing occupier needs

10

ContactEmma Grew Associate Director: Property Research +44 (0)20 3977 0951 emma.grew@mandg.com

Richard Gwilliam Head of Property Research +44 (0)20 3977 0980 richard.gwilliam@mandg.com

Lucy Williams Director, Institutional Business UK and Europe, Real Estate +44 (0)20 3977 1035 lucy.williams@mandg.com

Stefan Cornelissen Director of Institutional Business +31 (0)20 799 7680 stefan.cornelissen@mandg.co.uk

www.mandgrealestate.com

For Investment Professionals only. This document is for investment professionals only and should not be passed to anyone else as further distribution might be restricted or illegal in certain jurisdictions. The distribution of this document does not constitute an offer or solicitation. Past performance is not a guide to future performance. The value of investments can fall as well as rise. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and you should ensure you understand the risk profile of the products or services you plan to purchase. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. M&G does not offer investment advice or make recommendations regarding investments. Opinions are subject to change without notice. Notice to investors in the Netherlands. This document does not constitute investment advice or an offer to invest or to provide discretionary investment management services. Notice to investors in Singapore: This advertisement has not been reviewed by the Monetary Authority of Singapore. M&G Real Estate Pte. Ltd. (Co. Reg. No. 200610218G) may distribute information/research produced by its respective foreign affiliates within the M&G Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the information/research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, M&G Real Estate Pte. Ltd. accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact M&G Real Estate Pte. Ltd. at (65) 64365315 for matters arising from, or in connection with the information distributed. This information/research is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update. This document is issued by M&G International Investments S.A., registered office 16, Boulevard Royal, L-2449, Luxembourg. For the purposes of AIFMD, M&G Luxembourg S.A. acts as alternative investment fund manager of any funds cited in this document. M&G Real Estate Limited is registered in England and Wales under number 3852763 with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world’s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. JAN 19 / W335904

This advertisement has not been reviewed by the Monetary Authority of Singapore.