UK Market Commentary: Q4 2021

While UK economic growth will vary from month to month as the government tightens and lifts Covid-19 restrictions, Schroders forecasts that GDP on an annual basis will grow by 5% in 2022 and 3% in 2023.  The key drivers will be consumer spending and investment, as businesses look to raise productivity, switch to more energy efficient equipment and make use of the temporary increase in capital allowances.  The main downside risk is that the jump in inflation and staff shortages in construction, care homes, road haulage and other sectors spill over into a general wage-price spiral.  That would force the Bank of England to hike interest rates, which would hit consumption and house prices.  However, our main scenario is that inflation will slow through the second half of 2022, as supply chains normalise and last year’s surge in energy prices falls out of the annual comparison.  Accordingly, Schroders expects the Bank to raise base rate gradually to 0.5% by the end of this year and 1.0% by the end of 2023.

The arrival of Omicron during the all important run up to Christmas capped off a difficult year for retailers already struggling with on-line competition, rising costs and interruptions to supply.  We forecast that shop and shopping centre rents will fall by a further 10% over the next two years, as weaker retailers fail and surviving retailers shift more of their business online and close stores.  By contrast, supermarket and retail park rents will probably be stable.  The greater bias of retail parks to bulky goods means they are more internet immune than shopping centres and they have also benefited from being open air during a pandemic.  Next plc reported that its like-for-like sales on retail parks have returned to 2019 levels, whereas town centre sales are down by 15%.  The other key difference is that retail park rents and service charges are significantly lower than in shopping centres.  As a result, although some out-of-town retailers will fall into insolvency, we expect there to be steady demand for retail park units from discount retailers, gyms and coffee chains.

The office market appears to be past the worst.Take-up in the second half of 2021 was close to 2019 levels and vacancy rates in central London and major regional cities have levelled off at 10% and 8%, respectively. However, while fears that remote working would make offices redundant have proved wrong, demand has become much more focused on Grade A, high quality offices which have state of the art conditioning and connectivity, provide plenty of space for team working and are energy efficient. Over 70% of take-up in the City of London in 2021 was in offices with either a BREEAM1 excellent, or outstanding rating. This reflects the importance occupiers attach to attracting staff back into the office and to environmental targets. However, it also poses a serious challenge to secondary offices and the jump in construction costs over the last 12 months, means that some older offices risk becoming stranded assets, because it is no longer viable to refurbish them. Given the two-tier nature of demand and limited new building, we expect the increase in prime office rents which began last year in Cambridge, London and the big regional cities to continue through 2022-23. Rents on secondary offices in other cities are likely to decline, or at best stagnate.

Industrial take-up hit a new record in 2021, propelled by the growth in on-line retail.  Amazon alone committed to over 30 distribution warehouses and smaller “last-mile” units and the need to match Amazon’s delivery times put pressure on rival retailers to upgrade their logistics.  Last year also saw strong demand from pharmaceutical companies and trade counters and rental growth accelerated to 5%, from 2% in 2020.  Looking ahead over the next 2-3 years, rental growth is likely to slow to 3% p.a., partly because lower profit margins mean that on-line retail and logistics firms are very cost conscious and partly because of an increase in development of big distribution units.  Multi-let estates in stronger regional conurbations such as Birmingham, Leeds and Manchester could be an exception.  Rental growth has so far lagged behind that in London, but there is a similar combination of strong demand and tight supply.

The total value of investment transactions rose by a third in 2021 to over £60 billion, driven by strong interest from both UK and international investors.  The most liquid parts of the market were industrial and retail parks and both sectors saw a sharp fall in yields.  Prime yields on London multi-let estates and distribution warehouses fell to new lows of 3.0% and 3.5% respectively at the end of 2021, and prime retail park yields stood at 5.5%, down from 7.0% at the end of 2020.  In general transaction volumes in other sectors such as hotels, offices and residential recovered last year, but remained below pre-pandemic levels and yields were either stable, or fell by up to 0.25%.  The exceptions were care homes, shopping centres and leisure parks which remained generally illiquid, due to concerns about weak covenants.

We expect all property total returns to average 5-7% p.a. over the three years to end-2024.  While industrial is likely to remain one of the best performing sectors, we think that the favourable fall in industrial yields has now largely run its course, and that the gap in returns between it and other sectors will therefore narrow.  Retail parks and grade A offices should also out-perform, with the former supported by a relatively high income return of 6% and the latter benefitting from a steady increase in prime office rents in London and other winning cities.  By contrast, shops, shopping centres and secondary offices are likely to under-perform.  We think that certain niche types, including self-storage, social supported housing and retirement villages should also out-perform. 


1. Building Research Establishment’s Environment Assessment Method.

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