Real Estate

UK Property Market Commentary - June 2014

There is now firm evidence of a sustained and broad-based economic recovery in the UK, with the growth in domestic demand and household consumption stronger than many expected. Falling unemployment and further business investment as firms respond to increased demand from home and abroad, should help to sustain  productivity over the second half of the year.

4 July 2014

June 2014

Economy

There is now firm evidence of a sustained and broad-based economic recovery in the UK, with the growth in domestic demand and household consumption stronger than many expected. Falling unemployment and further business investment as firms respond to increased demand from home and abroad, should help to sustain productivity over the second half of the year.

In his Mansion House speech in June, Bank of England Governor Mark Carney warned that the first rise in interest rates may be sooner than the markets currently expect. Schroders has brought forward its interest rate forecast to February 2015, raising the end-2015 forecast to between 1% and 1.5%. With inflationary pressures benign, the Monetary Policy Committee may find it hard to justify anything more than a gradual rise in official rates in the near term. However, the measures announced in the latest Financial Stability Report targeting the residential market suggest the Bank remains cautious over the vulnerability of house prices.

Occupational Market

Many property sectors are now benefitting from improving occupational demand. For example, the evolution of parcel delivery networks and growth in services manufacturing is driving take-up in the industrial sector. Current market conditions in central London are helping to break down traditional location boundaries, with occupiers increasingly footloose and willing to migrate to more fringe office locations to access suitable space.

The development cycle has reached a low, with continued reluctance to lend on speculative builds and rising construction costs holding down the level of new starts across most sectors. The cycle may start to accelerate again given rental expectations but the development lag will benefit owners of existing property, particularly those with flexible space that meets the evolving requirements of the tenant base.

Investment Market 

The profile of investors into UK property is changing, with more domestic institutions bidding for assets, consultant-advised investors back in the market and increased allocations to real assets from traditional fixed income investors. International purchasers continue to target larger lot sizes in central London, but are also moving into regional markets. Investment volumes outside London are beginning to recover, particularly in cities such as Manchester, Leeds and Cambridge, where investment demand from buyers outstrips supply from potential vendors.

The demand for good quality assets across the UK market is pushing down pricing, with the yield spread narrowing between prime and secondary assets. This is being facilitated by an expanding group of lenders and a widening range of loan terms for those investors that need to access bank finance.

Outlook

The UK commercial property market is now entering the stage where capital values are being supported by rising rental values. We are forecasting total returns of between 7% and 9% per annum out to 2018, with an income return of around 5% per annum and capital growth of c. 3% per annum. Rental growth of between 2% and 5% should compensate for any rise in interest rates in the short term.

The changing political landscape presents one risk to our forecasts, whether that be volatility after a ‘Yes’ vote in the Scottish referendum or the uncertainty around the UK’s membership in the EU. There is also a risk that if the market moves too quickly in 2014, performance may become more front loaded than expected. However, the 5% to 5.5% income return from property continues to look defensive.

 

 

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