Economic and Property Market Overview: Q1 2017
UK Economic Overview
2017 has started to see the effects of Brexit feed its way through to the UK economy. After a strong end to 2016, economic activity softened in the first quarter of 2017. Construction output fell 1.7%m/m in February, industrial output also contracted by 0.7% over the same period, following a 0.3%m/m drop in January. The consumer sector is also showing signs of slowing. According to the ONS, the volume of retail sales growth was down 1.4% over the three months to March. A key contributor to this has been the acceleration in inflation, after hovering at sub-zero levels throughout most of 2015, CPI inflation has now surpassed the Bank of England's 2% target, climbing to 2.3%y/y in March. Meanwhile, the pickup in crude oil, imported materials and fuel prices from Sterling’s post referendum decline continues to raise input cost inflation which is now growing at an annual rate at 17.9% in March, compared to 16.8% at the end of 2016. This will erode the purchasing power of consumers in the months ahead as producers, manufacturers and retailers pass the steep input cost increases through the supply chain.
Labour market conditions were broadly undisturbed by Brexit’s developments, the number of people in employment rose by 39,000 over the three months to February, keeping the unemployment rate at a low of 4.7%. Moreover, more people were placed in full-time than part time employment, reflecting the desire from firms to increase the working hours of their staff. Yet despite the signs of optimism, earnings growth (including bonuses) stagnated, growing in line with CPI inflation (at 2.3%y/y in February), thus in real terms, average weekly earnings (including bonuses) are up 0.2% compared to the previous year, the slowest growth rate since 2014.
The collection of hard data signals slower growth prospects ahead, mirroring the recent readings on forward looking indicators. The purchasing managers’ indices (PMIs) slipped across all three main measures in early 2017, while early estimates of GDP growth for the first quarter of the year by the think-tank, National Institute for Economic and Social Research has come in at 0.5% (20bps lower than the Q4 2016 rate).
The Monetary Policy Committee are expected to keep a close eye on economic developments, particularly within the consumer economy. A benign interest rate outlook looks highly probable in the near term, as a lack of upward pressures on wage inflation limits domestically driven inflation.
Politics has moved back into the forefront, with the Prime Minister Theresa May confirming a snap election for the 8th June 2017. The announcement caused the pound to surge to $1.29 against the US dollar and €1.20 against the Euro. If the PM manages to raise the Conservative majority, thereby strengthening her negotiating stance this will mean that she will be able to proceed with her mandate without the disruption of a General Election in 2020.
UK Property Market Prospects
The commercial property market held up well during the first quarter of 2017, investment activity was supported by overseas investors (particularly from the Far East) who continued to make up the majority of transactions.
Most sectors have seen an improvement in capital values since the referendum with standard shops, leisure and industrial sectors having fully recouped their loss in values post referendum. Shopping Centres, West End and Rest of UK offices were the only exception, with capital values still at a discount to pre-referendum levels.
Meanwhile, occupational activity continues to support rental values, All Property rental growth was 0.3% for the three months to March, down from 0.5% in Q4 2016. A comparison of ERV growth by sector shows a clear disparity in performance. The industrial sector continues to charge ahead posting higher rates of rental growth than most other segments (of 1%), as a result of constrained supply and strong demand from third party retailers. Retail rental growth was patchy, with positive growth for standard shops in London, the South East, out of town shopping centres and retail parks, and falls elsewhere. Meanwhile, there were mixed fortunes in the office sector, rental values rose by 0.5% in the south east, and were unchanged in the rest of the UK, whereas there was a clear divergence in ERV growth in central London driven by the affordability of the individual submarkets, the City continued to post positive ERV growth of 0.5%, compared to a 0.6% fall for the West End for the three months to March.
Overall, All Property total returns were 2.3% for the first quarter of 2017, marginally down on its quarterly rate of 2.6% in December, if this momentum continues, commercial property could end the year delivering a total return in excess of 9.0%. We have re-assessed our medium term prospects given commercial property’s post referendum performance. Our All Property forecast total returns are 5.0%p.a. for the five years to 2021, based on the assumption that investor’s desire for higher yielding investments will support capital values from raised market volatility.