Economic and Property Overview: Q4 2018
UK Economic Overview
GDP growth moderated in the final quarter, after a strong summer; output grew by 0.3% for the three months to November, down 30bps on Q3. As expected, the service sector accounted for the largest share of growth adding 0.24 percentage points, the construction sector also contributed to GDP growth, while the production sector knocked 0.12 percentage points off growth owing to weak activity in the manufacturing sector, which suffered the longest period of month-on-month output falls since the financial crisis.
The latest IHS Markit / CIPS PMI business sentiment surveys suggest that firms are committing to more defensive strategies in light of the political uncertainty. Most UK service-led firms reported subdued growth conditions in December, which caused the services PMI to grow at its slowest rate since the Brexit vote. Construction firms also had a disappointing end to the year, with the PMI easing to a three-month low. In contrast, the manufacturing PMI strengthened in December, as businesses stockpiled goods in preparation for a disorderly Brexit.
The labour market remained undeterred by the uncertainty in the economy; employment and wages rose and the unemployment rate was unchanged at 4.0% for November, the lowest figure since mid 1970s. According to ONS, there were 141,000 more people in work in the three months to November compared to the same period to August, leading to the employment rate reaching a record high 75.8%. The number of job vacancies also hit record highs in December, with 858,000 job openings unfilled; which suggests that there is further scope for the unemployment rate to fall in the near term. Wages continue to respond to the labour market tightness; average earnings including bonuses increased 3.4%yoy in November, highest since the financial crisis, and amounting to a 1.2% increase in real wage growth.
The Consumer Price Index fell to 2.1% in December, its lowest level since January 2017. The steep downturn in oil prices which reduced the cost of petrol was responsible for most of the fall, a drop in airfares provided further relief. With the headline rate edging ever closer to the BOE’s 2.0% inflation target and political risks on the rise, the likelihood of interest rates increasing in the short term appears slim.
Christmas shopping started early this year. According to the ONS, online sales as a proportion of all retailing rose to 20% for the first time since records began. The improvement in e-retail sales coupled with increased sales of other non-food retail goods helped boost total retail sales volumes by 3.0%yoy in December. However, more timely data on the consumer economy has been less upbeat. The British Retail Consortium reported 0%yoy growth for total retail sales in December, and like-for-like retail sales of -0.7%yoy. A similar trend was seen in the Visa / IHS Consumer Spending Index which posted a 1.0%yoy decline in consumer spending in December. These data points coincide with the weaker readings on the GfK consumer confidence survey, which fell one point to -14 in December, 5 points lower than the start of 2018 and 7 points lower than the peak reached in Summer.
The prospects for the UK economy remains clouded by Brexit-related uncertainty. The rejection of Theresa May’s Brexit deal by Parliament in mid-January by 432 votes to 202 has left the Prime Minister with just ten weeks to draft a new deal that’s accepted by the EU and Parliament. A colossal task even for the best of leaders. A no-deal Brexit cannot be ruled out under the current circumstances, but an extension of Article 50 has also become increasingly likely.
UK Property Market Overview
2018 was a reasonably successful year for the UK commercial property market in the context of other asset classes. Despite the political drama and the casualties in the retail sector, UK property still managed to deliver a respectable total return of 7.3% for 2018 comfortably outperforming both UK equities and government bonds which returned -9.5% and 0.6% for 2018 respectively.
The All property total return was 1.1% in the final quarter. In contrast to prior quarters, hotels were the top performing sector in Q4 delivering a total return of 4.6%, this was followed by industrials at 3.4% and offices at 1.8%. Retail was the only sector to yield negative total returns of -1.9% in Q4, driven by the decline in retail asset values which accelerated in the final three months of the year by -3.3% compared to -1.3% in the previous quarter. All other sectors delivered positive capital returns ranging between +0.1% to +2.7%, with South East industrial sector sitting at the top of this range. In fact, with the exception of the retail sector, occupier conditions were reasonably solid at the end of the year. Central London office take up rose by 13% in Q4, according to CBRE, bringing total take up to 13.7m sq ft for the year, ahead of the totals for 2016 and 2017. Conditions in the industrial and logistics sector remain resilient too; take up reached a record high of 31.495m sq ft in 2018 up from 29.3m sq ft in 2017, according to CBRE.
At first glance, the conditions in the commercial property investment market appeared reasonably sound in December. The value of commercial property deals rose to £6bn in December from £3bn in November. However, December’s figure was boosted by the acquisition of Gatwick Airport by the French owned business, Vinci Airports for £2.9bn. Excluding this, the value of transactions was broadly the same over the two months. Institutional investors were also notably cautious in December in light of the increased political turbulence that followed the fail vote of no-confidence in the Prime Minister’s leadership of the Conservative Party in mid-December. The share of purchases by institutions was down 3% over the month, whereas the share of purchases by overseas investors ticked up from 52% to 53% over the same period.
Market conditions are likely to be more challenging for commercial real estate for the rest of this year with asset values expected to be vulnerable to a number of pressures: the ever-changing political climate; slower global growth; and the effects of any future high-profile retail administrations / CVA’s in the retail sector. We are forecasting c.3% total returns for UK property for 2019 to 2023, with income being the core driver of returns.