Economic and Property Overview: Q3 2018
UK ECONOMIC OVERVIEW
The UK economy had a strong start to Q3 2018, output grew by 0.7% for the three months to August, an uplift of 30bps from Q2. All three sectors of the economy: services, construction and the production sector contributed positively to GDP growth, with the service sector (accounting for c.80% of the UK economy) providing the largest positive contribution to the headline figure.
The latest business sentiment surveys suggests a moderation in economic growth in the short term; September’s IHS Markit UK Construction PMI dropped to 52.1 from 52.9 in August, albeit still above the 50.0 mark that signals growth, as hiring difficulties repressed the increased business activity in the sector. The Services PMI also edged down over the month from 54.3 to 53.9 in September. The readings are coherent with the HM Treasury’s latest views for GDP growth which is now expected to grow by 1.3% for 2018, 10bps lower than last quarter’s estimate.
The buoyancy in the UK’s labour market continued into Q3; the number of people in unemployment dropped by 47,000 over the three months to August, as a result the unemployment rate held firm at 4.0%, its lowest rate since the mid-1970s. Although, the Labour Force Survey showed the number of people in work was little changed, down by 5,000, leading to the employment rate stabilising at 75.5%. Even though at first glance headline employment data appears mediocre, analysis suggests the weakness reflects difficulty in recruiting suitable candidates instead of a weakening in demand for labour. Nevertheless, persistently low unemployment and hiring difficulties faced by firms is finally feeding through to wage growth; Worker’s regular monthly pay grew at their strongest rate in almost a decade in the year to August. Average earnings excluding bonuses rose by 3.1%yoy, higher than the 2.8% annual growth rate predicted by City economists; reflecting a 0.4% increase in real wage growth.
CPI inflation fell 30bps to 2.4% in September compared to August. Largest upward contribution continues to be transport services with prices rising by 5.5% in the year to September with other upward contributions from domestic utilities in which electricity prices rose 9.3% from September 2017. Unchanged food prices in 2018 provided the largest downward contribution to the September rate.
The continued hot weather and sustained real wage growth encouraged retail spend during the quarter; the quantity of retail goods bought increased by 1.2% in the three months to September due to strong sales in “other stores” and online retailing, which currently stands at 17.8% of all retail spend. There were also tentative signs to suggest that consumer spending habits are changing; the GfK consumer confidence index was maintained at -9 in September, on a par with the all-time average for the survey, but its Major Purchase Index, which asks consumers as to whether now is an ideal time to acquire major purchases was +6 in August and September, ahead of its annual moving average.
Brexit negotiations have been a roller-coaster ride of proposals and counter-proposals from both sides as the deadline to reach an agreement nears. Theresa May’s Chequers proposal faced fierce opposition domestically and from the EU before the summer break. After EU leaders rebuffed the Chequers plan at the EU summit in Salzburg in September, the Prime Minister publicly announced that the UK will not be bullied into a deal that would not benefit the British people. The next six months will be a testing time for the Prime Minister; an agreement must be in place by November to ensure a smooth transition in March 2019, a mammoth task given the longstanding issue of a frictionless Irish border remains unresolved.
UK PROPERTY MARKET PROSPECTS
UK commercial property market delivered a total return of 1.7% over the three months to September 2018, down 50bps compared to Q2 2018. Income returns held steady at 1.3% for the quarter, while the rate of capital growth slowed from 0.9%qoq in June to 0.4%qoq in September.
In a continued trend to last quarter, headline performance was supported by the industrial sector which outperformed the All Property total return by 1.8%. The sector’s performance was facilitated by strong capital growth for South East industrials (2.8% for the three months to September) as high demand and a lack of supply of good quality industrial and logistics space supported rental values.
Office occupier conditions remained firm over the quarter. According to JLL, a total of 5.1m sqft of office space was taken up in central London during first half of 2018, 13% above its long run average. Provincial office markets also reported an improvement in take up, particularly in the Western Corridor, Manchester and Glasgow. In total office take up across the regional core 8 office markets totalled 3.8m sqft in H1 2018, an improvement of 0.5m sqft compared to the same period a year earlier. Accordingly, all office segments delivered an increase in rental values over the quarter, with City offices delivering the strongest improvement in rental values of 0.7%.
The retail sector continued to feel the effects of CVAs and store closures. Rental values fell across all segments, with shopping centres and retail units in the Rest of UK experiencing the biggest declines of -0.5% and -0.9% respectively. Equivalent yields also softened, moving out 3bps between June and September to 6.03%. In aggregate, retail capital values were down 1.3% over the quarter, with high street retail in the Rest of UK faring worst with values falling by 1.9%. As a result, retail total returns were only marginally positive at 0.1% for the three months to September.
Activity in the UK’s capital markets remained strong in September, with the total value of commercial property deals reaching £4.8bn, 9% higher than a year earlier. Investment activity was dominated by overseas investors, although institutions and listed companies provided a small boost to total net investment. By sector, mixed use experienced the greatest amount of deal flow, boosted by Blackstone's Network Rail Portfolio acquisition for £1.5bn. Office transactions fell to £1.1bn, while the industrial and retail sectors both recorded muted levels of transactional activity.
Our five-year outlook for the commercial property market remains broadly unchanged over the quarter, we forecast 3.7%p.a. total returns for UK property for 2019 to 2023. Underpinning our market forecasts are modest declines in All Property capital values, driven by the weaker outlook for the retail sector and potential downward pressures from Brexit uncertainty. As a consequence, income returns will remain the key contributor to performance