Economic and Property Market Overview: Q3 2017
UK ECONOMIC OVERVIEW
The UK economy grew by 0.4% in the third quarter of 2017, following an expansion of 0.3% in Q2. The service sector was the key driver of growth, although other industries such as manufacturing sector also positively contributed to growth during the quarter. The latest Markit / CIPS PMI indices suggest softer growth for the second half of the year. The services PMI index was up over the month, but both the construction and manufacturing indices declined. The construction PMI contracted for the first time since the Brexit vote from 51.1 in August to 48.1 for September, while the manufacturing PMI index fell from its four-month high of 56.7 in August to 55.9 in September.
Meanwhile, the pressure on household’s real incomes continues to build. CPI inflation rose from 2.6% in July to a 5 year high of 3.0% in September on account of increases in clothing, footwear and furniture prices. Average earnings growth also decreased, albeit subtly, from 2.2% in July to 2.1%for the three months to August.
The pressure on consumer incomes was evident on retail sales. According to the ONS, the volume of goods purchased (exc. fuel) increased at an annual rate of 1.2% in September. However, the monthly figures showed a contrasting trend, with the quantity of goods bought falling by 0.8% mom in September.
The UK’s labour market continues to go from strength to strength. A total of 94,000 people were employed over the three months to August keeping the unemployment rate at 4.3%,its lowest rate since 1975. However, with productivity growth moving sideways rather than up, the chances of tighter labour market conditions providing a significant boost to earnings growth appear slim.
The recent increases in inflation and economic growth will provide policymakers with enough ammunition to consider increasing interest rates in the short term. While, the majority of Monetary Policy Committee members voted 7-2 in favour of keeping rates on hold in September, intentions to raise rates in the near future were evident from the minutes of the meeting. As a result, economists now forecast a base rate rise as early as November. However, subsequent increases in rates are unlikely given the ongoing headwinds (UK’s rising debt problem, the continued squeeze on real incomes and the forthcoming Brexit negotiations) that hang over the UK economy.
UK PROPERTY MARKET PROSPECTS
The performance of the UK commercial property market continued its ascent in Q3. According to the IPD Monthly Index, All Property total returns were 2.7% for the three months to September up from 2.5% in June. Market returns were supported by a buoyant industrial sector, where returns were more than 2% above the All Property average. Overall, this brings the All Property total return to 7.6% for the year to date, pointing to a return of c.10% for the year as a whole.
Occupier trends remained unchanged over the quarter. Demand for industrial space continued to grow, fuelled by strong take up from online retailers (which accounted for 33% of the total industrial take-up in the first half of 2017).
Performance across the retail sector remains uneven, with positive rental growth delivered in tourist hotspots, the South East and the retail warehouse sector, and zero / negative growth recorded elsewhere. Meanwhile, the leisure sector continued to benefit from the weakness in Sterling and increased tourist numbers as rental growth continued to strengthen over the quarter. As for the office sector, most segments reported positive rental growth over the quarter, with South East offices leading the sector (ERV growth was 0.8% for the three months to September). The West End office market was the only exception to this trend, with rental values remaining static over the three months to September.
Investment activity has also been encouraging, albeit the total value and number of deals transacted in September were down compared to the previous month. At £3.7bn, the total value of investment deals made in September were 13% lower than in August. Nonetheless, overseas investors continue to show a keen interest in UK property, with the value of net purchases equating to £790m in September, compared to c.£1bn in August.
The appetite for UK property could slow in the near term, the recent implementation of capital controls on mainland China is expected to slow the activity of China’s most acquisitive investors, and speculation that the Treasury may introduce restrictions on local authorities acquiring investments outside their own jurisdictions in the Autumn Statement could also take some of the steam out of the investment market in the short to medium term.
We forecast a total return of 4.3% p.a. for All UK Property for the next five years (2018 to 2022). Market segments delivering income returns that are in line or ahead of the market, low obsolescence and some insulation to Brexit’s effects should offer the best opportunities for investors over the forecast period.