Real Estate Research
UK Property Market Commentary - 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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