Lockdown prolongs capital values falls - Capital Economics
UK Commercial Property

Lockdown prolongs capital values falls

UK Commercial Property Chart Book
Written by Andrew Burrell
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With rental and capital values falling at a slower pace in recent months, this had seemed to suggest that pricing was bottoming out. But the near-term outlook for most commercial property sectors has been dampened further by the second lockdown. We expect all-property rents and capital values will decline further in the next few months.

  • With rental and capital values falling at a slower pace in recent months, this had seemed to suggest that pricing was bottoming out. But the near-term outlook for most commercial property sectors has been dampened further by the second lockdown. We expect all-property rents and capital values will decline further in the next few months.
  • Economic indicators indicate that even before the national lockdown, the recovery seemed to be running out of steam. But the fall in the composite flash PMI from 52.1 in October to 47.3 in November suggested that the hit to GDP from the second lockdown will be much smaller than the first.
  • Market intelligence show that although take-up in the regional office markets improved from Q2’s low, it remains well below normal levels. But a relatively tight supply pipeline will mean that regional office rents hold up better than in London and the South East in the next few years.
  • At an all-property level, rental values fell at the same rate as the previous month. In October, rental values fell by 0.3% m/m. This was driven by sharp declines in leisure and retail rents. In fact, rents in the leisure sector fell at their fastest rate since September 1999. And restrictions, weak tourist flows and subdued incomes will continue to undermine the hospitality sector well into next year. (See our Outlook.)
  • All-property equivalent yields fell slightly again in October. Despite this, the falls in rental values meant that all-property capital values declined again, albeit by just 0.1% m/m, the same pace as the month before. But, an improvement in industrial returns meant that all-property annual total returns improved for the third consecutive month from minus 2.7% in September, to minus 2.5% in October. (See Chart 1.) Looking ahead, we think further falls in capital values will mean that returns are set to worsen in the coming month.

Chart 1: Total Returns by Sector (% y/y)

Source: MSCI


Economic Indicators

  • By the end of Q3, the economic recovery seemed to have run out of steam. GDP rose by just 1.1% m/m in September, leaving the economy still 8.2% smaller than it was in February (2). The second lockdown will reduce GDP again, although the relatively small fall in the composite flash PMI from 52.1 in October to 47.3 in November suggests that the hit to GDP will be much smaller this time (3).
  • The 1.2% m/m increase in retail sales in October means that sales are now 6.8% above their pre-virus level (4). But the current lockdown means that retail sales will probably fall in November. Meanwhile, in response to the government asking firms to shoulder a greater burden of the cost of their furloughed employees, firms reduced their staffing levels in September. In the three months to September, employment fell by 164,000 (5). This pushed the unemployment rate up from 4.5% to 4.8% and despite the extension of the furlough scheme out to March, we think unemployment will climb further in the coming months.
  • The increase in CPI inflation to 0.7% in October from 0.5% in September shows that inflation is well past its recent low point of 0.2% in August (6). With inflation well below the Bank of England’s 2% target, we expect that Bank Rate will remain at 0.1% over the next few years. While the 10-year Gilt yield has edged up from 0.2% in October to 0.31% so far this month, we expect it will remain low (7).

Chart 2: Level of Monthly GDP (February 2020 = 100)

Chart 3: Composite PMI

Chart 4: Retail Sales (February 2020 = 100)

Chart 5: Employment (Millions)

Chart 6: CPI Inflation (% y/y)

Chart 7: 10-Year Gilt Yield and Bank Rate (%)

Sources: Refinitiv, Markit, ONS, Capital Economics


Market Indicators

  • According to Colliers, transaction totals were down from £4.5bn in September to £3.5bn in October (8). But, compared to a year ago, investment improved in all sectors. In fact, retail investment was almost double the level seen in October 2019. Meanwhile, industrial and office investment rose by 55% y/y (9).
  • In Q3, take-up in the regional office markets improved from a low point in Q2. Avison Young report that regional take-up increased by 70% q/q to 1.3m. sq. ft. in Q3, but the level of activity in the regions remains very low compared to pre-COVID-19 levels (10). Nevertheless, we think regional office rents will hold up better than in London and the South East in the next few years due to a tighter supply pipeline (11).
  • CBRE report that Central London office take-up totalled just 200,000 sq. ft. in October, down 50% from a weak September (12). At the same time, a rise in available second-hand space resulted in availability rising 6% m/m to 21m. sq. ft., its highest in over 10 years. As such, vacancy increased from 6.5% in September to 7% in October and a large development pipeline implies further increases in the next 12 months (13).

Chart 8: Investment Deals Completed (£bn, monthly)

Chart 9: Value of Deals Completed by Sector (£bn)

Chart 10: Regional Office Take-Up (M. Sq. Ft.)

Chart 11: Years of Supply in the Regions (Based on 5-Yr Avg. Take-Up)

Chart 12: Central London Office

Chart 13: Central London Office Development Pipeline (M. Sq. Ft.)

Sources: Colliers, Avison Young, CBRE, Deloitte


Rental Values

  • All-property rents fell by 0.3% m/m in October for the second consecutive month (14). This was driven by sharp declines in leisure and retail rents, with shopping centres faring particularly poorly (15). At minus 1.8% m/m, rents in the leisure sector fell at their fastest rate since September 1999.
  • The retail sector extended its long run of falling rents in October, with rents declining by 0.9% m/m (16). At minus 8.7% y/y, retail rents fell at their fast rate since records began in 1987. While retail sales have risen to 6.8% above their pre-virus level, this largely reflects growth in online spending. Conversely, footfall is well below its pre-virus level and has plummeted since the second lockdown forced non-essential retailers to close (17). Low footfall and rising vacancies will continue to weigh on retail rental values.
  • The 0.1% m/m fall in all-office rental values in October was driven by weakness in London and the South East (18). And we expect more downward pressure to be exerted on office rents as tenants look to offload excess space. Meanwhile, all-industrial rents rose by 0.1% m/m. While the Rest of South East industrial rents increased, both the Rest of UK industrial rents and Distribution Warehouse rents fell for the first time since 2013, taking their annual growth rates down to their lowest since 2014 (19).

Chart 14: All-Property Rental Values (%)

Chart 15: Rental Values by Sub-Sector (% m/m)

Chart 16: Retail Rental Values (% m/m)

Chart 17: Retail Footfall Index

Chart 18: Office Rental Values by Sub-Sector (%)

Chart 19: Industrial Rental Values by Sub-Sector (%)

Sources: MSCI, Capital Economics, Springboard


Yields & Capital Values

  • All-property equivalent yields fell slightly again in October (20). Yields in all the traditional sectors edged down, with retail falling by 4bps, the first fall in retail yields since January 2018 (21). This was due to a 66bps m/m fall in shopping centre yields, partly offsetting the 81bps rise in September (22). But, with the UK in lockdown in November and restrictions remaining thereafter, the outlook for retail remains gloomy. We expect rising retail yields to put upward pressure on all-property yields in the coming months.
  • At minus 0.1% m/m in October, capital values declined at the same pace as in September (23). The recent declines in capital values have mostly come from falling rental values (24). The second lockdown and expansion of areas under Tier 2 and Tier 3 measures could cause an acceleration in rent and capital values declines in the last few months of the year.
  • Meanwhile, annual total returns improved for the third consecutive month from minus 2.7% in September, to minus 2.5% in October. Although returns were stronger in the industrial and retail sectors again, office returns slowed further to 0.1% from 0.6%, their lowest since December 2009 (25). Looking ahead, we think that capital value falls will accelerate in the coming months, which will dampen returns again.

Chart 20: All-Property Equivalent Yields (%)

Chart 21: Equivalent Yields by Sector (%)

Chart 22: Retail Equivalent Yields (%)

Chart 23: All-Property Capital Values

Chart 24: Contribution to All-Property Capital Value Growth (%-pts m/m)

Chart 25: Total Returns by Sector (% y/y)

Source: MSCI


Data Summary and the Month Ahead

Table 1: Economic Indicators

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Real GDP, %y/y

1.0

1.0

-2.1

-21.5

-9.6

Real GDP, %q/q

0.3

0.1

-2.5

-19.8

15.5

Financial and business services output, %y/y

0.8

0.4

0.2

-10.9

-7.6

FBS employment, %y/y

2.7

2.0

1.9

-1.8

Distributive trades output, %y/y

1.8

1.2

-4.4

-37.4

-6.2

Household spending, %y/y

0.9

0.0

-2.9

-26.2

-12.7

Net new lending to commercial property, £bn

1.2

0.0

4.8

0.1

Total outstanding property debt, £bn

159.5

163.0

167.7

170.7

Lending to property as a % of all lending

6.8

6.9

6.9

7.0

5-year swap rate, %, average over the quarter

0.70

0.81

0.66

0.38

June. 2020

Jul. 2020

Aug. 2020

Sept. 2020

Oct. 2020

Manufacturing output, %y/y

-10.1

-8.4

-8.0

Employment, %y/y

-0.3

-0.3

-0.8

ILO unemployment rate, %

4.3

4.5

4.8

Retail sales volumes, %y/y

1.2

2.6

4.6

5.8

EC UK Economic sentiment index

75.5

75.1

83.0

84.6

78.6

CPI inflation, %y/y

1.0

0.2

0.5

0.7

Nationwide house prices, %y/y

1.5

3.7

5.0

5.7

Bank of England repo rate, %

0.10

0.10

0.10

0.10

0.10

10-year gilt yield, %, average over the month

0.18

0.10

0.17

0.17

0.20

5-year swap rate, %, average over the month

0.30

0.20

0.20

0.18

0.20

Sources: Nationwide, Bank of England, Refinitiv

Table 2: Upcoming Data

 

Latest Number

Next Release Date

Period Covered

Nationwide house prices, %y/y

5.7

1st Dec.

Mar.

Oct.

CIPS manufacturing sector PMI

53.7

1st Dec.

Mar.

Nov.

CIPS construction sector PMI

53.1

4th Dec.

Nov.

CIPS services sector PMI

51.4

3rd Dec.

Nov.

Manufacturing output, %y/y

-8.0

10th Dec.

Sept.

CPI inflation, %y/y

0.7

16th Dec.

Nov.

Employment, %y/y

-0.8

15th Dec.

Oct.

ILO unemployment, %

4.8

15th Dec.

Oct.

Retail sales volumes, %y/y

5.8

18th Dec.

Nov.

Bank of England repo rate, %

0.10

17th Dec.

Dec.

MPC minutes (tighten/no change/loosen)

0/9/0

17th Dec.

Dec.

MSCI Quarterly index

Feb

Q4

MSCI Monthly index

14th Dec.

Nov.

.

Bank Lending to Property

4th Jan

Nov.

BoE Credit Conditions Survey

21st Jan.

Q4

RICS Construction Survey

4th Feb.

Q4

RICS Commercial Property Survey

28th Jan.

Q4

Sources: Nationwide, IHS Markit, Refinitiv


Andrew Burrell, Chief Property Economist, andrew.burrell@capitaleconomics.com
Prohad Khan, Property Economist, prohad.khan@capitaleconomics.com
Sam Hall, Assistant Property Economist, sam.hall@capitaleconomics.com