Weak start to the year for property - Capital Economics
UK Commercial Property

Weak start to the year for property

UK Commercial Property Chart Book
Written by Andrew Burrell
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The rise in all-property capital values in late-2020 proved short-lived and they flattened off again in January. The recent roadmap for easing England’s current lockdown is broadly consistent with our previous expectations for the recovery, so the outlook for property remains weak in the near term. As a result, there is likely to be further downward pressure on all-property capital values in H1.

  • The rise in all-property capital values in late-2020 proved short-lived and they flattened off again in January. The recent roadmap for easing England’s current lockdown is broadly consistent with our previous expectations for the recovery, so the outlook for property remains weak in the near term. As a result, there is likely to be further downward pressure on all-property capital values in H1.
  • Economic indicators show that the lifting of restrictions for some of December supported a rise in services output GDP growth, though overall GDP still declined by almost 10% during 2020. Meanwhile, a fall in employment pushed the unemployment rate up from 5% in November to 5.1% in December.
  • Market intelligence show that, on a 12-month rolling basis, investment transactions totalled £3.1bn in January, which was down 11% from a year ago. This weakness has been largely due to a fall in office investment, as retail activity was stable and industrial transactions rose.
  • All-property rental values fell by 0.1% m/m in January, reversing the growth of 0.1% m/m in December. The decline was driven by retail and leisure, while office rents stabilised. Elsewhere, industrial was the only sector to record rental growth, albeit also at a slower rate than in recent months.
  • All-property equivalent yields have been falling since August and they fell slightly further in January. Nevertheless, this was not enough to sustain continued growth in capital values. (See Chart 1.) Meanwhile, annual total returns strengthened from minus 1% in December to minus 0.8% in January, but we expect some of these gains to be reversed in Q1.

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

Source: MSCI


Economic Indicators

  • With restrictions lifted for some of December, a rise in service sector output supported GDP growth of 1.2% m/m. This left the economy 6.3% below its pre-crisis level in December (2). But the third lockdown probably meant that GDP fell in January. Looking ahead, with virus cases falling sharply and the fast rollout of vaccines, we expect the economy to revive as restrictions are gradually lifted from Q2 (3).
  • The 8.2% m/m slump in retail sales volumes in January took sales to 5.5% below their pre-crisis level (4). Meanwhile, employment fell by 114,000 in the three months to December. This pushed the unemployment rate from 5% in November to 5.1% in December and we think it will peak at 6.5% by the end of this year (5).
  • CPI inflation rose from 0.6% y/y in December to 0.7% y/y in January (6). But we expect the rate will jump to 2% y/y in April, as last year’s fall in fuel price falls drops out of the index and the temporary hospitality VAT cut ends. That said, we expect the Bank of England will keep the Bank Rate at 0.1% this year. Meanwhile, the 10-year Gilt yield has risen from 0.3% in January to 0.75% in late-February, but we expect it will remain close to this level for the rest of year (7).

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

Chart 3: COVID Cases and Hospital Patients

Chart 4: Retail Sales Volumes (February 2020 = 100)

Chart 5: ILO Unemployment Rate (%)

Chart 6: CPI Inflation (% y/y)

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

Sources: Refinitiv, ONS, Capital Economics


Market Indicators

  • According to Colliers, on a 12-month rolling basis, investment transactions totalled £3.1bn in January, which was down 11% from a year ago after a weak start to 2021 (8). This was largely due to office activity being down by 36% y/y in January while, on the same basis, retail investment was close to its total last year. At the same time, industrial investment was up by almost 50% y/y (9).
  • CBRE report that Central London office take-up was just 272,000 sq. ft. in January, down 70% from a year ago (10). Over the same period, availability increased by 80% to 24.3m. sq. ft.. Around 5m. sq. ft. is expected to complete this year, which will maintain new supply at similar levels to 2019-20 (11.) With less than a third pre-let, we think this will add to the upward pressure on vacancy.
  • Take-up in the South East office market remained weak in 2020. According to Knight Frank, at 678,000 sq. ft. in Q4 2020, take-up was down 30% on Q4 2019 (12). The office vacancy rate rose from 6.4% to 7.2% but remained lower than its post-GFC peaks or during the 2016-17 UK office downturn (13). This at least should help limit rental falls in the region.

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

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

Chart 10: Central London Offices

Chart 11: CL Under Construction (M. Sq. Ft.)

Chart 12: South East Office Take-Up (M. Sq. Ft.)

Chart 13: South East Office Vacancy Rate (%)

Sources: Colliers, CBRE, Knight Frank, Avison Young


Rental Values

  • After a surprising upturn in rental growth during December, all-property rents fell by 0.1% m/m in January (14). The decline was driven by retail and leisure which were likely hit by renewed closures under lockdown, while office rents stabilised. Industrial was the only sector to record growth (15).
  • That said, even industrial rents recorded a broad-based slowdown (16). As a result, all industrial rental growth slowed to 2.2% y/y in January from 2.3% y/y in the previous month (17). But, with tight COVID-19 restrictions set to last until H2, we think this will sustain demand by retailers for online capacity, which will keep occupier demand at high levels. We expect this will help support an acceleration in rental growth this year.
  • For the sectors that have seen the worst hit to rents, though leisure rents fell at a faster pace, retail rental falls slowed. In January, retail rents fell by 0.3% m/m after a 0.5% m/m drop in December. This reflected a slowdown in standard shop and retail warehouse rental falls (18). Meanwhile, leisure rents declined by 0.2% m/m from minus 0.1% m/m (19). With the recent announcement that indoor hospitality will return no earlier than mid-May, we expect that operators will be squeezed further by prolonged closure.

Chart 14: All-Property Rental Values (%)

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

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

Chart 17: Industrial Rental Values

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

Chart 19: Leisure Rental Values

Sources: MSCI, Capital Economics


Yields & Capital Values

  • All-property equivalent yields have been gradually falling since August. They fell by a marginal 2bps m/m in January (20). While yields in the office and retail sectors stabilised, industrial yields continued to fall, albeit at a slower pace, declining by 6bps compared with 9bps in the month before (21). This reflected a slowdown in RoSE yields falls (22).
  • At the all-property level, after rising by 0.5% m/m in December, capital values were flat in January (23). The rise in industrial values, albeit slower than in recent months, offset a fall in capital values in other sectors (24).
  • Annual total returns have become less negative in recent months, strengthening from minus 1% in December to minus 0.8% in January. While industrial and retail returns improved, office returns continued to deteriorate last month (25). At minus 1.2% in January, annual office returns recorded their worst outturn since December 2009. And in the near-term, we think that all-property returns will deteriorate again over the coming months.

Chart 20: All-Property Equivalent Yields (%)

Chart 21: Equivalent Yields by Sector (Bps, m/m)

Chart 22: Industrial Equivalent Yields (Bps, m/m)

Chart 23: All-Property Capital Values

Chart 24: Capital Values by Sector (% m/m)

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

1.2

-2.2

-21.0

-8.7

-7.8

Real GDP, %q/q

0.0

-2.9

-19.0

16.1

1.0

Financial and business services output, %y/y

0.4

0.0

-10.0

-6.2

-4.9

FBS employment, %y/y

1.7

1.5

-2.1

-3.4

Distributive trades output, %y/y

1.2

-4.7

-36.8

-5.7

-12.3

Household spending, %y/y

1.2

-2.4

-23.3

-8.6

-8.4

Net new lending to commercial property, £bn

0.0

4.8

0.0

0.6

-0.4

Total outstanding property debt, £bn

163.0

167.7

170.6

169.8

167.8

Lending to property as a % of all lending

6.9

6.9

7.0

6.9

6.9

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

0.81

0.66

0.38

0.58

Sept. 2020

Oct. 2020

Nov. 2020

Dec. 2020

Jan. 2020

Manufacturing output, %y/y

-6.5

-5.4

-2.6

-2.4

Employment, %y/y

-0.8

-0.9

-1.2

-1.6

ILO unemployment rate, %

4.8

4.9

5.0

5.1

Retail sales volumes, %y/y

4.5

6.0

2.3

3.1

EC UK Economic sentiment index

85.9

87.4

81.5

87.1

CPI inflation, %y/y

0.7

0.3

0.6

0.7

Nationwide house prices, %y/y

5.0

5.8

6.4

7.2

6.4

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

0.20

0.34

0.28

0.30

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

0.18

0.20

0.25

0.23

0.25

Sources: Nationwide, Bank of England, Refinitiv

Table 2: Upcoming Data

 

Latest Number

Next Release Date

Period Covered

Nationwide house prices, %y/y

6.4

2nd Mar.

Mar.

Feb.

CIPS manufacturing sector PMI

54.1

1st Mar.

Feb.

CIPS construction sector PMI

49.2

4th Mar.

Feb.

CIPS services sector PMI

39.5

3rd Mar.

Feb.

Manufacturing output, %y/y

-2.4

12th Mar.

Jan.

CPI inflation, %y/y

0.7

24th Mar.

Feb.

Employment, %y/y

-1.6

23rd Mar.

Jan.

ILO unemployment, %

5.1

23rd Mar.

Jan.

Retail sales volumes, %y/y

3.1

26th Mar.

Feb.

Bank of England repo rate, %

0.10

18th Mar.

Mar.

MPC minutes (tighten/no change/loosen)

0/9/0

18th Mar.

Mar.

MSCI Quarterly index

6th Mar

Q1.

MSCI Monthly index

12th Mar.

Feb.

.

Bank Lending to Property

1st Mar.

Jan.

BoE Credit Conditions Survey

15th Apr.

Q1

RICS Construction Survey

6th May.

Q1

RICS Commercial Property Survey

29th Apr.

Q1

Sources: Nationwide, IHS Markit, Refinitiv


Andrew Burrell, Chief Property Economist, andrew.burrell@capitaleconomics.com
Prohad Khan, Property Economist, prohad.khan@capitaleconomics.com