Real Estate Research
UK Real Estate market commentary - Q3 2018
After a slow start to this year, UK economic growth accelerated over the summer driven by consumer spending and a rebound in house-building and inventories.
After a slow start to this year, UK economic growth accelerated over the summer, driven by consumer spending and a rebound in housebuilding and inventories. Schroders forecasts that GDP will grow by 1.2% in 2018 and 1.3% in 2019 and that the Bank of England will gradually raise interest rates to 2% in 2020. This assumes that there is a Brexit deal and that the UK retains access to the EU single market until the end of 2020. While there will be a lot of political jockeying over the next few months, it is in both sides’ interests to agree a soft border between Northern Ireland and Ireland and the principles for free trade in agriculture and goods. What is less clear is how much access UK financial and professional services will have to the EU single market after 2020.
As expected, although average capital values are continuing to increase, there is significant polarisation between the sectors due to both structural and cyclical factors.
Despite the growth in retail sales, several retailers and restaurants have fallen into administration, or entered into a company voluntary arrangement (CVA) in 2018 and other profitable chains are closing stores. More than 4,000 units have been affected and 1 in 8 are vacant. While this has been blamed on numerous factors (e.g. the rise in the national minimum wage, private equity, business rates, a decline in materialism), the most important has been the failure of many retailers to adapt to an omni-channel world. The internet’s share of total retail sales has jumped from 5% in 2008 to 18% and estimates suggest it could climb to 30% in 10 years’ time. Retail rents in most locations are likely to fall over the next couple of years. On the upside, the shake-out will create opportunities to bring successful retailers into schemes and increase the mix of residential and other uses in town centres.
By contrast, industrial rents in the year to August rose by 6% in London and the South East and by 3% in the rest of the country. In part the gap reflects that manufacturing is still an important driver of warehouse demand in the Midlands and the North, despite the boost from online retail. It also probably reflects the greater loss of industrial estates to housing in the South. In response, the Mayor of London’s draft plan recommends that any further demolitions are balanced by new provision elsewhere, including multi-storey warehouses. Looking ahead, we expect that industrial rental growth will slow over the next couple of years, as the developers build more big distribution warehouses and as second hand space from failed retailers comes back to the market.
Office markets appear well placed to weather any slowdown in the economy. In most cities demand and supply are in equilibrium and the total amount of office space is only growing modestly, as new building is offset by residential conversions, particularly in southern England. As a result, we expect office rents in the South East and big regional cities to be broadly flat, or rise slightly over the next couple of years. The exception is the City of London where the total amount of office space will increase by around 7% over the three years to end-2020. While many schemes are pre-let, a lot of second-hand space will become vacant once occupiers move and we expect City office rents to fall by 10% through 2018-2020. Inevitably, this will have a knock on effect on the West End and Inner London, although office rents there should be more defensive given less new development.
Provisional figures suggest that the total value of investment deals fell by 15% over the first nine months of 2018 compared with the same period in 2017. Unsurprisingly, much of the decline has been in the retail sector where a number of potential deals have fallen through. There have also been fewer sales of big City offices, possibly because of the uncertainty created by Brexit. Conversely, the regional office and industrial investment markets have remained very competitive and yields have continued to edge down. There is also a lot of interest in private rented housing, despite the low level of yields.
Capital values in the main commercial markets are now moving in opposite directions for the first time in 15 years, demonstrating that there is no such thing as a single UK real estate cycle with regular peaks and troughs. For example, some secondary shopping centre values could fall by more than 20% over the next two years, whereas industrial and regional office capital values should increase or hold steady. Our main focus for diversified portfolios is on industrial / logistics serving large population centres and offices in winning cities such as Bristol, Leeds and Manchester. Certain parts of the London office market benefiting from structural change (e.g. Crossrail stations, Shoreditch) remain attractive. We are also investing opportunistically in certain niche sectors and strategies (e.g. self-storage, real estate debt and residential land) which should be less correlated with the main commercial markets.
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