Economic and Property Market Overview: Q4 2016
UK Economic Overview
The final quarter of 2016 was marked by a series of political events. The election of Donald Trump as US President and his pledge to boost US growth through increased infrastructure spend and tax cuts has renewed fears of faster interest rate hikes in the US, while the resignation of the Italian Prime Minister Matteo Renzi over the recent referendum defeat has raised concerns that populist parties with anti-globalisation agendas could be gaining ground across Europe. Closer to home, Brexit continues to dominate the UK’s medium term growth outlook, although the run of decent economic data to date, coupled with a more accommodative monetary and fiscal backdrop have caused many agencies, including the Bank of England to upwardly revise their near term growth outlook.
Improving confidence has re-emerged across a number of sentiment based surveys over the quarter. The Deloitte CFO Survey climbed to an 18-month high in Q4 as CFO’s took on a slightly more optimistic outlook on the business climate than at any point over the last 18 months. A similar trend was seen in the UK’s composite PMI which was up over the month from 55.3 to 56.7 in December, its highest level since July 2015. The results suggest that GDP growth should not disappoint in Q4. In fact, early estimates point to a quarterly GDP growth rate of 0.5% for the final quarter, which would result in an annual growth rate of 2.0% for 2016, a fairly respectable figure given the political turmoil witnessed over the second half of the last year.
The consumer sector also appears to be holding its ground, with various retailers reporting a bounce back in trading conditions and like for like sales over the Christmas period. On a more worrying note, the factor driving Britain’s spending splurge is a rise in borrowing, with lending on unsecured debt from credit cards and bank overdrafts to debt financing on car purchases growing at annual rates of 9%+. The eventual unwinding of this debt could stunt the UK's longer term growth prospects.
Inflation is also picking up pace, as the effects of a weaker pound have started to feed through to import prices. The annual rate of CPI inflation rose by 40bps over the month from 1.2%yoy to 1.6%yoy in December.
On the whole, the UK economy should start 2017 on a good note, but whether or not the post-referendum trends seen to date will continue throughout the rest of the year will depend on how the economy copes with the forthcoming Brexit negotiations. It will not be easy, the Prime Minister Theresa May has stated that the UK will leave the EU on a hard Brexit arrangement (i.e. with no access to the single market in exchange for full control over immigration), which could result in a knock to business confidence and investment and put further downward pressure on Sterling over the short term. A weaker Sterling may well be good news for the UK’s export industry, but it will be less of a welcome for the nation’s households who will be burdened by the higher costs of goods and lower levels of discretionary spend.
UK Property Market Prospects
A steady improvement was seen in the performance of the UK property market returns during the quarter. According to the IPD monthly Index, All Property capital values rose by 0.7% in the final month of the year, (up from 0.3% in the previous month), as a result of a marginal compression in yields and a continued uplift in all property rental value growth, which lead to a capital value increase of 1.1% over the three months to December, and an All Property total return of 2.6% for the quarter and for the year as a whole. Unsurprisingly, the industrial sector posted the strongest returns in the final three months of 2016, delivering twice the level of return than the other main use sectors. On a brighter note, the central London office market recovered some ground, with values in the City office market rising by 1.8% over the quarter (compared to 0.1% for the three months to November).
Although the Brexit negotiations will continue to have an overarching influence on both the UK economy and property markets, there are still good reasons to believe that the UK property market will deliver reasonable returns over the next 12 months. Overseas buyers have remained active players in the marketplace and recent investment activity by retail funds has improved. Moreover, as long as a low interest rate environment remains in place, then the hunt for yield will still be at the forefront of investors interests. Thus, against this backdrop, commercial property should continue to remain an attractive asset class for investors.
Our five year forecasts for commercial property are broadly in line with previous quarters. Capital values are likely to fall given the various economic risks but the rates of decline may well be dampened by the strong flows of money within the investible universe. On the whole, income will remain the dominant component of total returns over the five year period.