Economic and Property Market Overview: Q4 2017
UK ECONOMIC OVERVIEW
The UK economy grew by a stronger than expected 0.5% in Q4, resulting in an annual GDP growth rate of 1.8%, the slowest rate of growth since 2012 but higher than the 1.5% forecast just two months ago in the Autumn Budget. Whilst this level of growth is now below that of the Eurozone, comments from the Bank of England suggest that the UK could reconnect with strengthening global growth to provide stronger numbers over the next couple of years despite Brexit.
Britain’s manufacturers finished the year on a high note as a synchronised global economic recovery and a weak pound boosted manufacturing output (up 3.9% over the three months to November). The same factors aided business sentiment; the Markit / CIPS Manufacturing PMI index recorded its strongest reading since Q2 2014 in December and the Services PMI also improved from 53.8 in November to 54.2 for December. The Construction PMI was the only outlier with the index slipping from 53.1 to 52.2 over the month, but with December’s figure sitting comfortably above 50, a modest expansion in construction activity is expected.
The annual rate of CPI inflation dipped 10bps to 3.0% in December owing to the slower rate of growth in exchange rate sensitive goods such as food, games, toys and airline fares. Yet against a backdrop of subdued wage growth, average earnings excluding bonuses grew by 2.4% over the three months to November, households still remain poorer off in real terms.
Despite the recent pressures on discretionary spend, various datasets have reported an improvement in consumer spending in December compared to the same month a year earlier. According to the British Retail Consortium, total retail sales were up 1.4%yoy in December, however the headline figures mask the underlying trends in spending patterns; rising prices led to shoppers committing a higher proportion of their earnings on essential items; and more goods were consumed online than in-store, as consumers took advantage of discount days such as Black Friday and the chance to compare prices more effectively online. As a result, high street footfall was down 3.5%yoy in December, although footfall across retail parks fared better.
There was more positive news on the labour front, as the number of people in work increased by 102,000 in the three months to November, reversing the fall in employment seen in the three months to October. The announcement caused gilt yields to rise and Sterling to strengthen against the Dollar (to $1.41), its highest level since the referendum.
Opinions are split on how the BoE will react to an above target rate of inflation. To date, policymakers have placed more weight on inflation than growth, given the recent increase in the base rate in November despite convincing macro data, where policymakers go from here however is less clear; The expectations for Sterling’s post-referendum depreciation to gradually fall out of CPI inflation rate towards the latter half of the year and Brexit to cast a shadow over the economy’s short term outlook provides reasons to keep interest rates on hold for longer, but in the event that the recent improvements in the jobs market puts upward pressure on wages could result in another rate increase as early as Q2 2018.
UK PROPERTY MARKET PROSPECTS
The commercial property market ended the year on a better note than had been forecast twelve months before. According to the IPD Monthly Index, the All Property total return was 3.5% in the final three months of the year raising the annual total return to 11.2% for 2017, well ahead of the returns achieved on fixed income assets (UK Gilts 1.8%), and surprisingly close to the performance delivered from UK equities (FTSE All Share total return was 13.1%, while the FTSE 100 delivered 12.0% for the year).
Quarterly returns were bolstered by the performance of the industrial sector where returns reached a high of 7.4% in the South East on account of strong investor sentiment and positive rental growth. Alternative assets also performed well, outperforming the All Property average by 0.8% over the quarter. There was also limited evidence of Brexit’s effect on the London office market; performance was up over the previous quarter, and returns were comparatively stronger in the City than the West End (2.3% v 2.1% respectively). Regional offices also maintained their recent run of healthy performance delivering a total return of 3.3% for the three months to December, compared to 2.2% in September. Retail was the only sector that lacked any material improvement in performance, apart from South East Retail where total returns were up 0.5% to 2.3% in December, performance in all other retail segments either remained unchanged or weakened over quarter.
Looking forward, we expect commercial property returns to moderate from the double digit figures achieved over the last three years. We forecast 4.0%p.a. total returns from UK property for 2018 – 2022 and project that the current polarisation in sub-sector performance will be sustained over the forecast period, with sectors that are set to benefit from the disruptions of technology, demographic trends and strong market fundamentals to deliver a more prosperous outlook.