UK Property Market Commentary - December 2013
31 December 2013
The UK economy currently appears to be in good health. GDP grew by 0.8% in the second quarter of 2014 (source: ONS), lifted by an increase in consumer spending and by an upturn in house building and business investment. The one disappointment has been exports which have been held back by the anaemic recovery in the Eurozone. While consumer price inflation has recently been benign, running at 1.5% per year (source: ONS), Schroders nevertheless expects the Bank of England to raise interest rates in early 2015 as a preventative measure to stop the economy from over-heating.
The improvement in the economy has started to ripple out from London, boosting demand for office space along the Thames valley and in certain regional cities. Manchester has so far been the most buoyant market this year with a number of large lettings to lawyers and other professional service companies, but there has also been a significant recovery in office demand in Bristol, Edinburgh, Reading and Sheffield (source: Knight Frank). We also see opportunities in some other locations with strong economies such as Brighton, Cambridge and Milton Keynes.
The pick up in office demand is echoed in the industrial market. Industrial rents in London, the South East and Midlands are now rising by 2% per year (source: IPD) and there also signs of life in northern England. Part of this is due to a cyclical upturn in demand from traditional occupiers such as builders merchants, but part is also due to the rapid growth in parcels (+5% in the past year, according to PwC), driven by online retail.
Although retail sales grew by an impressive 4% (source: ONS) over the year to August in volume terms, the fact that prices for clothing, food and household goods are flat or falling is a reminder that many retailers continue to struggle. As a result we remain sceptical about the potential for widespread rental growth in the retail market and prefer either convenience stores, which are benefiting from the switch to “small basket shopping”, or retail warehouse units which provide retailers with efficient and affordable space.
In total there were £20 billion of investment transactions in the first half of 2014, up 30% on the first half of 2013 (source: RCA). Most of the increase in activity was in the regions, as both domestic and foreign investors have become less fixated on London. Consequently, property yields in most regions have fallen by 0.5% to 1.0% (source: IPD) since the start of 2014, although spreads against London yields continue to look attractive.
We believe that the vast majority of capital currently being invested is equity rather than debt. While the big UK banks have now worked through a lot of their problem assets and insurers and debt funds have stepped up their activity, lenders remain fairly conservative about the assets they will lend on and who they will lend to.
The momentum within the UK economy is being matched by activity and sentiment in the property market. Growing occupational demand is radiating out of the capital into the regions, alongside high levels of transactional activity. We believe that this should result in strong total returns of between 15% and 20% in 2014.
Looking forward, we expect total returns to average 6% to 7% per year between end-2014 and end-2018 based on an income return of 5% and steady rental growth of 2% to 3% per year, assuming the UK economy continues to grow. The big uncertainty in the short-term is investor sentiment. If the average property initial yield settles at around 5.25% in 2015 then annual total returns should be reasonably stable over the next few years. However, if investors bid down property yields aggressively by a further 0.5% in 2015, then there is a risk that increasing interest rates lead to falling capital values in 2016-2017. While the Scottish referendum is now over, the 2015 general election and the possibility of a referendum on EU membership will start to play on investors’ minds.
The views and opinions contained herein are those of Schroder Property Investment Management Limited and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.