Economic and Property Market Review: Q1 2018
UK ECONOMIC OVERVIEW
The UK economy had a reasonably good start to the year. The employment picture remains encouraging, 55,000 jobs were created in the three months to February, resulting in the unemployment rate slipping to 4.2% (from 4.3% in January). Wages are also on the rise; average earnings (excluding bonuses) were up 2.6% over the three months to January, the fastest growth rate in more than two years. With the number of unfilled job vacancies now standing at a record high and various hiring intention surveys reporting recruitment difficulties, the recent pick up in nominal wage growth should be sustained in the short term.
There has also been evidence of a pick up in UK productivity. Output per hour increased by 0.8% over the three months to December, following a 0.9% increase over the three months to September. The gains were also relatively broad-based with two-thirds of British industries seeing productivity growth surpass their pre-crisis averages during the second half of 2017.
Inflation also surprised on the upside; CPI inflation fell from 2.7%yoy in February to a one-year low of 2.5%yoy in March. There are good reasons to believe that these price declines will be part of a sustained trend. Producer price inflation (a measure of the price of raw materials and fuels that have either been imported or bought domestically by UK manufacturers and a good lead indicator of CPI inflation) rose by 4.2%yoy in March, significantly lower than the annual growth rates seen a year earlier. Shop prices have also declined, falling 1.0%yoy to March, providing further proof that the impact of sterling’s depreciation is starting to fade.
An early Easter helped boost retail sales during the quarter, according to the British Retail Consortium total retail sales were up 2.3%yoy in March. More money was spent on food than anything else as consumers sacrificed spending on non-essential items due to reduced spending power. However, improvements in retail sales failed to raise footfall on the high street which was down 0.5% over the year to February, as a combination of bad weather and the chance to seek deals online kept shoppers from venturing out to the high street.
The momentum in sentiment surveys softened in March, after a strong February. The Markit / CIPS Services PMI index fell to 51.7 from 54.5, the weakest performance since July 2016. The Construction index was also down, falling from 51.4 in February to 47 in March, the fastest decline since July 2016 and below the 50 mark that corresponds with an expansion in output. Weather related disruption was the key factor behind this month’s declines. The manufacturing PMI fared better however, maintaining its value at 55.1 from 55.0 in the previous month. With two of the three indices above 50, subdued economic growth is expected for the first quarter of 2018.
As for Brexit and its effect on UK businesses, various surveys are suggesting that corporations are becoming less concerned on its impact on business prospects. According to the Lloyds Business Barometer survey, 36% of businesses surveyed with a turnover over £1m were more positive on the post Brexit outlook, up from 26% in the previous quarter. The Deloitte Survey of UK Chief Financial Officers (CFOs) delivered a similar message; business confidence marginally improved over the quarter, and now sits close to its long run average, and for the first time in two years Brexit is no longer the key concern for CFO’s, with a slowing economy now shifting into the top position.
UK PROPERTY MARKET PROSPECTS
The UK property market started 2018 on a positive note. According to the IPD Monthly Index, the All Property total return was 2.3% for the three months to March 2018. Capital values rose by 1.0% over the period, half the rate of growth seen in the three months to December, but a 10bps improvement on the growth rate delivered this time last year. Income was the largest component of performance making up the remaining 1.3% of the quarter’s total return.
Occupier conditions remained firm in Q1, All Property rental values rose by 0.4%qoq in March, compared to 0.6% for the three months to December. Rental values were up across most segments except for the standard retail market, where a number of retail and restaurant administrations weighed on occupier demand. Retail warehouses and shopping centres managed to remain unscathed from the recent weakness in retail activity, rental values rose by 0.1% and 0.2% respectively during the quarter. South East industrials continued to lead all other segments, posting rental growth of 1.3% over the quarter, but as expected, the rate of growth softened (ERV growth was 1.6% for the three months to December). Occupational conditions in the office sector were also reasonably resilient, City Office rental values increased by 0.3% during the quarter, while West End, South East and Rest of UK Offices reported similar gains, with the rate of growth ranging between 0.3 to 0.5% over the quarter.
Investment activity softened in the first three months of the year, a total of £2.5bn of commercial property deals completed in March, 28% lower than February’s total. A lack of large deals and a general disinterest from investors to the retail sector were among the key reasons for this month’s decline. On a brighter note, overseas investors (from the Far East in particular) remain acquisitive and the largest source of capital in Q1. Plus, unlike 2017 investment activity has also become more diversified; just over £300mn was invested into UK property by UK REITs in March and institutions and private investors were also net investors over the month.
We are reasonably optimistic that the UK property market will continue to perform in line with recent trends over the course of the next nine months. Supply conditions across most areas of the market (barring standard retail) are at a ten-year low, and future supply is likely to be held back by tighter lending conditions and Brexit uncertainty. Improvements in the labour market should also provide some support to rental values in the short term. But with the current headwinds in the retail sector and Brexit fast approaching, it is fair to assume a minor decline in All Property capital values in the near term.