Still too early to call a turn in property - Capital Economics
UK Commercial Property

Still too early to call a turn in property

UK Commercial Property Chart Book
Written by Andrew Burrell
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A return to rental growth and stronger capital value growth in December hint to a turnaround in UK commercial property. But this was a surprising development and we think it is too early to call the recovery given the headwinds in early 2021. With virus restrictions likely remain in place until March and then only gradually unwound afterwards, we think this will continue to put upward pressure on yields and rule against a rebound in investment activity in the coming months.

  • A return to rental growth and stronger capital value growth in December hint to a turnaround in UK commercial property. But this was a surprising development and we think it is too early to call the recovery given the headwinds in early 2021. With virus restrictions likely remain in place until March and then only gradually unwound afterwards, we think this will continue to put upward pressure on yields and rule against a rebound in investment activity in the coming months.
  • Economic indicators show that, owing to the second lockdown, the economy contracted by 2.6% m/m in November, which left the economy 8.6% below the pre-crisis level. And renewed restrictions mean early 2021 is likely to remain weak.
  • Market intelligence show that investment transactions totalled £6.7bn in December, well down on the £10.1bn seen in December 2019. Looking ahead, we think that falling capital values and economic uncertainty are likely to prevent any spectacular rebound in investment activity in the coming months.
  • At an all-property level, rental values grew in December for the first time since September 2019. (See Chart 1.) Growth was fastest in the industrial sector, though the declines in retail were also less steep.
  • All-property equivalent yields fell slightly in December, the fifth consecutive monthly decline. But a rise in rental values meant capital values grew by 0.5% m/m. Meanwhile, annual total returns improved from minus 1.9% to minus 1% but we think falling all-property capital values in the coming months will dampen returns again.

Chart 1: All-Property Rental Value Growth (% m/m)

Source: MSCI


Economic Indicators

  • With the return of lockdown in November, GDP fell by 2.6% m/m, leaving the economy 8.6% below the pre-crisis level (2). COVID-19 case numbers have fallen back in recent days, but they remain very high. What’s more, the number of virus patients in hospital has continued to grow (3). This means that severe restrictions will likely remain in place until March and then only ease gradually in the following few months. Even that is reliant on a speedy vaccine rollout. But with over 4million people having received their first dose so far, that appears to be broadly on track (4).
  • Meanwhile, the rebound in December’s retail sales was cut short by the closure of many shops before Christmas. The 0.3% m/m rise in retail sales in December left sales 2.7% above their pre-virus level. Daily data of card payments so far this month shows consumption fell to about 35% below pre-virus level (5).
  • CPI inflation rose to 0.6% y/y in December from 0.3% y/y in November, driven by a jump in transport costs (6). We think inflation will rise more sharply from April when the temporary VAT cut for the hospitality sector is reversed and the downward drag from the previous falls in fuel prices drops out of the annual comparison. Nevertheless, we expect the BoE to keep Bank Rate at 0.1% this year. Meanwhile, the 10-year Gilt yield has been stable this month at close to 0.3% (7). We see it rising to 0.5% by year-end.

Chart 2: Monthly Real GDP (February 2020 = 100)

Chart 3: COVID Cases and Hospital Patients

Chart 4: Number of People Vaccinated (Millions)

Chart 5: Retail Sales & CHAPs Card Payments (% v Feb)

Chart 6: CPI Inflation (% y/y)

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

Sources: Refinitiv, ONS, Capital Economics


Market Indicators

  • Colliers report that investment transactions totalled £6.7bn in December, which was well down on the £10.1bn from December 2019 (8). While industrial investment picked-up slightly, the weakness was largely due to a decline in office and alternative investment. Further, we think that pressure on capital values will probably prevent any rebound in activity in the coming months.
  • According to CBRE, industrial take-up fell by around 20% q/q to 10.4 m. sq. ft. in Q4 after a record high quarter in Q3 (9). Nevertheless, take-up in Q4 was still high by historic standards. This prompted a fall in availability to 21.2m sq. ft. from 25.2m sq. ft. in Q3 with new supply unable to respond fast enough (10).
  • Central London office take-up was just 853,000 sq. ft. in Q4, down almost 80% from a year ago (11). Over the same period, weak take-up meant that the availability rate increased from 5.4 % to 10% (12). With completions this year likely to reach their highest level since 2009, we think availability has further to rise in the next 12 months (13).

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

Chart 9: Industrial Take-Up (M. Sq. Ft.)

Chart 10: Industrial Availability (M. Sq. Ft.)

Chart 11: Central London Take-Up (M. Sq. Ft.)

Chart 12: Central London Availability Rate (%)

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

Sources: Colliers, CBRE


Rental Values

  • Having fallen by 0.1% m/m in November, all-property rental values grew by 0.1% m/m in December. This was the first month of growth since September 2019 (14). The improvement compared to November was seen in all sectors outside retail and hospitality, with industrial seeing the strongest growth (15).
  • All the industrial sub-sectors saw rental growth (16). As such, at 0.6% m/m, all-industrial rents grew at their fastest pace since June 2018 (17). While we think industrial will be the only sector to record rental growth this year, we expect that even he pace of growth will slow down in the next few months.
  • While there has been a slowing in the rate of retail rental value falls, they continue to fall. In fact, standard shops rents fell at a faster pace than the 0.9% m/m decline in November, at minus 1.1% m/m in December (18). This follows tough restrictions in the run-up to the busy Christmas period, particularly in London and the South East, which would have impacted heavily on high streets in the MSCI sample. With severe restrictions likely to last until at least March, we think this will lead to more retail insolvencies and further downward pressure on rents. Meanwhile, office rents returned to growth for the first time since February, rising 0.1% m/m in December (19).

Chart 14: All-Property Rental Values (%)

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

Chart 16: Rental Values by Sub-Sector (% m/m)

Chart 17: Industrial Rental Values (% m/m)

Chart 18: Retail Rental Values (% m/m)

Chart 19: Office Rental Values (% m/m)

Sources: MSCI, Capital Economics, ONS


Yields & Capital Values

  • All-property equivalent yields have been falling since August and edged down a further 2bps m/m in December (20). This partly reflected solid demand for industrial assets, where yields fell by 9bps. Conversely, retail yields continued to rise, albeit only by 3bps (21). This was largely driven by a 34bp m/m rise in shopping centre yields (22). And with restrictions likely to remain tight in the coming months and a poor rental outlook, we think retail yields have further to rise in 2021.
  • All-property capital values grew by 0.5% m/m in December, after a 0.2% m/m rise in November. This was driven by another improvement industrial capital values, though the fall in retail also moderated (23). But two months of all-property capital growth were not enough to prevent values falling by 6.3% y/y in December (24). Before 2020, the last time values fell this sharply was in November 2009. Looking ahead, we think this trend will be temporary and that all-property capital values will fall again in 2021.
  • At an all-property level, annual returns strengthened to minus 1% in December, from minus 1.9% in the previous month. Although industrial and retail returns improved, office returns continued to deteriorate last month (25).

Chart 20: All-Property Equivalent Yields (%)

Chart 21: Industrial Equivalent Yields (Bps m/m)

Chart 22: Retail Equivalent Yields (%)

Chart 23: Capital Values by Sector (% m/m)

Chart 24: All-Property Capital Values

Chart 25: Total Returns by Sector (% p.a.)

Source: MSCI


Data Summary and the Month Ahead

Table 1: Economic Indicators

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Real GDP, %y/y

1.0

-2.1

-21.5

-9.6

Real GDP, %q/q

0.1

-2.5

-19.8

15.5

Financial and business services output, %y/y

0.4

0.2

-10.9

-7.6

FBS employment, %y/y

2.0

1.9

-1.8

Distributive trades output, %y/y

1.2

-4.4

-37.4

-6.2

Household spending, %y/y

0.0

-2.9

-26.2

-12.7

Net new lending to commercial property, £bn

0.0

4.8

0.0

0.6

Total outstanding property debt, £bn

163.0

167.7

170.6

169.8

Lending to property as a % of all lending

6.9

6.9

7.0

6.9

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

0.81

0.66

0.38

0.58

Aug. 2020

Sept. 2020

Oct. 2020

Nov. 2020

Dec. 2020

Manufacturing output, %y/y

-7.1

-6.5

-6.1

-3.7

Employment, %y/y

-0.8

-0.9

ILO unemployment rate, %

4.8

4.9

Retail sales volumes, %y/y

2.7

4.5

5.9

2.1

2.9

EC UK Economic sentiment index

75.1

83.0

84.6

78.4

84.3

CPI inflation, %y/y

0.5

0.7

0.3

0.6

Nationwide house prices, %y/y

3.8

5.0

5.8

6.4

7.2

Bank of England repo rate, %

0.10

0.10

0.10

0.10

0.10

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

0.17

0.17

0.20

0.34

0.28

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

0.20

0.18

0.20

0.25

0.23

Sources: Nationwide, Bank of England, Refinitiv

Table 2: Upcoming Data

 

Latest Number

Next Release Date

Period Covered

Nationwide house prices, %y/y

7.2

29th Jan – 3rd Feb.

Mar.

Jan.

CIPS manufacturing sector PMI

57.5

1st Feb

Jan.

CIPS construction sector PMI

54.6

4th Feb

Jan.

CIPS services sector PMI

49.4

3rd Feb

Jan.

Manufacturing output, %y/y

-3.7

12th Feb.

Dec.

CPI inflation, %y/y

0.6

17th Feb.

Jan.

Employment, %y/y

-0.9

26th Jan.

Nov.

ILO unemployment, %

4.9

26th Jan.

Nov.

Retail sales volumes, %y/y

2.9

19th Feb.

Jan.

Bank of England repo rate, %

0.10

4th Feb.

Feb.

MPC minutes (tighten/no change/loosen)

0/9/0

4th Feb.

Feb.

MSCI Quarterly index

3rd Feb.

Q4

MSCI Monthly index

12th Feb.

Jan.

.

Bank Lending to Property

1st Feb.

Dec.

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