Economic and Property Overview: Q2 2018
UK ECONOMIC OVERVIEW
The UK economy grew by 0.3% over the three months to May, an uplift of 10bps from Q1’s GDP growth. Construction output which shrank by 0.8% last quarter, flat-lined in April, before resurging in May by 2.9%mom, while services output, which accounts for c.80% of the economy, increased by 0.4% over the three months to May. The ONS’s new monthly measure of economic activity has moved in accordance with the Purchasing Managers’ Indices which have strengthened in recent months following the blast of wintery weather in March. The composite PMI score rose again in June to 55.2 (from 54.5 in May); the figures suggest that the economy will expand by 0.4% q/q in the second half of the year, a similar pace of growth to that seen at the end of 2017; this would imply a GDP growth rate of 1.4% for 2018, in line with the Bank of England’s projections.
The labour market remained a standout performer during the quarter. The economy added 137,000 jobs over the three months to May, generating a record high employment rate of 75.7%. In total, 177,000 full-time jobs were created, this was partially offset by a decrease of 40,000 part-time jobs reducing underemployment in the UK economy. Meanwhile, the number of people unemployed fell by 12,000 from March to May, resulting in the unemployment rate holding firm at 4.2%, its joint lowest rate since 1975. The ONS reported a small decline in regular pay growth of 0.1% to 2.7% from March to May, which was disappointing given the increase in employment. The data could provide ammunition for the BoE to keep rates unchanged in August, given that the recent wage growth figures indicate a lack of inflationary pressure in the domestic economy.
CPI inflation remained unchanged at 2.4% in June; which was welcomed by households who have seen their saving contributions deplete in the last two years. Rising motor fuel prices produced the largest upward contribution to inflation, although this was partially offset by downward pressures from clothing and footwear as the summer sales began.
The hotly anticipated World Cup and a spell of warm weather failed to bolster consumer spend in June, according to the ONS, retail sales volumes declined by 0.5%mom in June as consumers substituted shopping on the high street for food and drink to complement the warm weather. On a more positive note, retail sales volumes rose by 2.1% for the three months to June, the largest increase since February 2015, with growth across all main sectors, and food stores delivering the strongest three-month on three-month growth since May 2001 of 2.2%. Meanwhile, the GfK consumer confidence indicator slipped two points over the month to –9 in June, due to bleak expectations of the general economic situation in the UK. It remains too early to tell whether this points to slower consumer spending ahead, as relative to historic readings, June’s score remains high.
Turbulence returned to the UK Government shortly after the quarter. Just days after the Prime Minister (PM) secured cabinet agreement over the Brexit Plan, key cabinet ministers, Brexit Secretary David Davis and Foreign Secretary Boris Johnson resigned over the PM’s proposals for the UK to maintain close trade ties with the European Union post Brexit. To date, the Prime Minister has been able to withstand the resignations and the threats of a leadership challenge while the response from financial markets to the mayhem has also been fairly muted; Sterling dipped below $1.32 after the departures, but recovered thereafter, while the FTSE 100 climbed after the news.
UK PROPERTY MARKET PROSPECTS
The UK property market continued to outperform expectations into Q2. The All Property total return was 2.2% for the three months to June compared to 2.3% in Q1. Capital values rose by 0.9% over the period, only 10bps lower than the growth rate achieved over the three months to March and income returns remained stable at 1.3% for the quarter.As a result, UK property has delivered a return of 4.5% for the first six months of the year.
The divergence in sector performance widened over the quarter; South East Industrials continued to charge ahead, delivering a total return of 5.9% over the quarter, (up from 5.2% in Q1); followed by regional industrials which returned 3.8% for the period. City Offices, Rest of UK Offices and the Other sector were the only other market segments to deliver returns in excess of the All Property average (of 2.6%, 2.3% and 2.6% respectively), while West End and South East Offices delivered slightly softer returns compared to last quarter. Within the retail sector, South East Standard Retail was the most resilient segment with total returns 20bps lower than the previous quarter (1.0% for Q2 compared 1.3% in Q1). Retail Warehouse total returns remained positive at 0.8% for the quarter, 70bps down from the total return achieved in Q1, while total returns nudged into negative territory for Rest of UK Standard Retail and Shopping Centres. In fact, contrary to recent headlines, Rest of UK Standard Retail was the weaker of the two, with a total return of -0.4% for the quarter versus -0.2% for Shopping Centres.
Every retail segment suffered negative rental value growth in Q2, with Shopping Centres and Rest of UK Standard Retail faring worst; rental values declined by 0.8% and 0.7% respectively over the quarter compared to a 0.3% decline for Retail Warehouses and South East Retail. All other non-retail segments benefitted from positive rental value growth with City Offices, Rest of UK Offices and South East Industrials witnessing an improvement in rental value growth during the quarter.
We have revised our 2018-22 all property total return forecast down from 4.6% p.a. to 3.7% p.a. Our 2018 all property total return now stands at 3.9% and we have adjusted our 2019 total return forecast from 4.0% to 2.7%, off the back of more negative capital growth, most heavily influenced by weaknesses in shopping centres and retail parks. This being said, the shift from instore to online retail will further support industrial performance going forward. Supply remains limited across most sectors, due to a shortage of speculative development surrounding Brexit fears. This, coupled with low levels of unemployment should maintain positive rental growth over the forecast period as income continues to be the main driver of returns.