Our latest UK economic downgrades mean that it is now inevitable that there will be a big hit to commercial property values, which we expect to fall by around 10% this year. And while conditions are different to the GFC and the shock should be short and sharp, a full-blown crash is not out of the question.
- Our latest UK economic downgrades mean that it is now inevitable that there will be a big hit to commercial property values, which we expect to fall by around 10% this year. And while conditions are different to the GFC and the shock should be short and sharp, a full-blown crash is not out of the question.
- Moves toward greater containment over recent days have led to steep downgrades to our UK view. (See our UK Economic Update.) Our forecast is now that UK GDP could fall by as much as 15% q/q in Q2, despite recent emergency fiscal and monetary measures. This is a temporary, if very severe, disruption however, and the economy is expected to recover much of this ground by the end of 2021.
- Property is better in theory placed to weather the disruption than other financial assets, as rents are generally contracted for several years, so much income is secure. But the deeper and more prolonged the crisis, the more downward influence new leases, breaks or re-negotiations will exert. And of course, there is a growing risk of existing tenants defaulting. So it is unlikely that rents will be unscathed.
- From an investor point of view, valuations were not alarming pre-COVID. But as we noted in our recent Update, risk premia were already likely to widen after the financial market disruption. What’s more, containment and travel restrictions now bring a shutdown in some activity, not just a slowdown.
- We still think that transactions will be hit harder than prices, but property yields are now expected to increase further. In our new central case, we have factored in a 50bp increase and a 10% one-off fall in rents during Q2, given the severity of the slump, though we assume a reversal as the crisis dissipates.
- The initial impact is severe, with all-property capital values down very sharply in Q2. (See Chart 1.) But as rents recover and the initial yield increase unwinds, there is a reversal. Nonetheless, 2020 is still expected to be a tough year for property, with capital values down by 9.4% and returns of minus 4.8%. (See Table 1.) This is in part compensated by the rebound during 2021 as the market returns to normal.
- Admittedly current uncertainty is huge, and a more extreme downside with a weaker recovery cannot be ruled out. This would push us closer to previous crashes, with values down by more than 25% this year as a result. But the GFC market contraction lasted more than two years and this shock should be briefer. And with no debt-fuelled investment boom and supply tight in many markets, some risk factors are absent. In addition, further mitigation may come from more aggressive policy measures if the crisis is prolonged.
- Forecasting in the current environment is clearly difficult as developments are fast moving and any estimate is liable to date. But based on our current base case, we think that there will be a sizeable, if temporary, correction in property values this year, but not a crash.
Chart 1: All-Property Capital Values (% y/y)
Chart 2: UK All-Property Forecasts
Sources: MSCI, Capital Economics
Sources: MSCI, Capital Economics
Andrew Burrell, Chief Property Economist, +44 7958 902 151, email@example.com