Economic and Property Market Overview: Q2 2016
UK Economic Overview
The UK public voted to leave the European Union on 23rd June, to the surprise of pollsters and economists. The margin was tight at 4%, although in absolute terms this represented a 1.25 million difference in votes between the leave and remain camp. There is already growing evidence of the Brexit effect on both the economy and financial markets. Sterling has depreciated in value against the Dollar and the Euro to levels last seen in the early 80’s. Share prices have fluctuated and business and consumer confidence has diminished.
The drop in confidence levels has affected business investment with some firms (particularly SME’s) placing large scale investment plans on hold. The demand for new staff has also cooled, with the number of jobs advertised online at half the levels seen prior to Brexit. Evidence on the consumer front is somewhat mixed. Although there have been reports that footfall is holding up, some of the bigger anchor retailers (such as John Lewis) have posted falls in weekly retail sales.
Only time will tell whether these early indicators are short-lived or the start of a more persistent downward trend, but there are signs of more challenging times ahead. The IMF has downgraded the UK’s economic growth prospects from 2.2% to 1.3% for 2017. Moreover, inflation is on the rise. CPI inflation rose from 0.3%yoy in May to 0.5%yoy in June. This could be the first of many price increases, particularly if ongoing Brexit negotiations keep Sterling under pressure, causing import prices to rise, discretionary spending to fall and the consumer outlook to become more muted over the medium term.
The Governor of the Bank of England (BoE), Mark Carney appears less concerned over the inflation outlook and more focussed on economic stability. In a recent speech, Carney clearly expressed his views on using further monetary action both in the form of interest rate cuts, further QE and cuts to bank’s capital requirements to stimulate the economy and assist bank lending conditions. Whilst the BoE surprised the market by keeping the base rate on hold in July, there are expectations that a rate cut is on the cards in August once more official data on the economy is obtained.
UK Property Market Prospects
The property market has not been immune from the heightened market uncertainty. Share prices of UK real estate companies have re-priced, and increased outflows on open ended commercial property funds have forced some of the larger investment houses to suspend redemptions or introduce redemption penalties to protect their liquidity positions and delay or prevent the sale of assets at deeply discounted prices.
Limited transactional activity has made it difficult to see where current pricing on the direct property market stands, however anecdotal evidence suggests that the discounting on direct commercial stock has been less severe than on property funds, with some long leased, low yielding central London assets transacting at a c.5% discount.
We have revised our forecasts for the commercial property market in light of the recent changes. There are a number of plausible ways in which the UK could exit the EU. We believe an EEA or Soft Exit arrangement that introduces some restrictions on the access to the single market and migration, but gives the UK freedom to negotiate trade deals outside the EU is the most likely outcome.
Against this backdrop, we expect a capital value correction of 5-10%p.a across direct property segments over the next 6-12 months, followed by a recovery in values towards the back end of the forecast period. As expected, central London offices are the most susceptible to Brexit (given their dependence on the financial service sector). In contrast, Retail, Industrials and the Alternative sector should be less affected. Of course, each sector will have its own issues, but, on the whole, it will be those investments that are well located that should retain healthy levels of occupier demand and a greater level of resilience during this period of increased uncertainty.