Economic and Property Overview: Q1 2020
UK ECONOMIC OVERVIEW
The first quarter of 2020 was shaped by the coronavirus, by the end of March 2020 a total of 29,474 confirmed cases and 2,352 deaths were reported for the UK. One month after the quarter end, the number of cases and deaths surged to 194,990 and 29,427 respectively. The costs to the British economy have been considerable; government-imposed lockdown measures to slow the spread of the virus have disrupted business activity, knocked consumer confidence and reduced business confidence levels to record lows. The flash PMI’s plunged from 53.0 in February to 37.1 in March, with a figure of 50+ representing economic expansion, it is now widely anticipated that the economy will contract in March.
Although March saw an unprecedented rise in the demand for food, essentials and online retail goods, the closure of many non-essential stores led to record falls in retail sales. The BRC Retail Sales monitor recorded a 4.3% y/y fall in sales in March while a separate report by Barclaycard, which captures nearly half of all UK credit and debit card transactions, reported a 6%y/y decline in consumer spend during the same period.
Falling oil prices and reduced demand for consumer goods caused CPI inflation to fall in March. According to the Office for National Statistics (ONS) the annual growth rate fell from 1.7% in February to 1.5% in March. Housing, fuel and water prices were key downward contributors to the headline rate. March’s data, which largely covers the period before the lockdown measures were imposed, provides a brief glimpse of things to come, with some economists predicting a sub 1% out-turn in the coming months.
Official data on the UK’s labour market following the lockdown measures is yet to be released, but more timely data on universal credit claims from the Department for Work and Pensions, signal a higher unemployment rate in the coming months. More than 1.8 million people have claimed welfare payments since the beginning of March, almost five times higher than the same period a year ago. Economists at KPMG and Capital Economics estimate that the rise in benefit claims could push the UK’s unemployment rate from its current low of 4% to 9% in the near term.
The introduction of several fiscal and monetary policy measures by the Government and the Bank of England (BOE) (which at the time of writing included £60bn of public spending, a 65bps cut in the BOE’s base rate to 0.1% and the resumption of quantitative easing through the purchase of £200bn of assets, predominantly gilts) aimed at increasing the supply of credit to firms and shoring up household incomes, will be key to curbing the economic disruption caused by the pandemic.
PROPERTY MARKET OVERVIEW
The first quarter of 2020 was forecast to be a good quarter for UK property market with the resounding Conservative party win expected to deliver a boost to occupational and investor demand but the positive gains from the general election result were swiftly replaced by the disruptive effects of COVID-19. The All Property total return on MSCI’s Monthly Universe fell over the quarter from +0.3% in Q4 2019 to -1.4% for the three months to March as yields increased and capital values contracted across all sectors of the property market.
The retail sector, which was already battling structural change prior to the onset of Covid-19, faced further challenges this quarter. The enforced closure of non-essential shops to contain COVID-19 significantly reduced retail footfall, with the retail experts Springboard, reporting an 80% year-on-year fall in daily footfall for the 31st March. Many retailers and leisure operators have sought rental holidays, switched to monthly rental payments or turnover-based rental systems to reduce costs and manage cashflow problems, but for many occupiers, already struggling to stay afloat, the pandemic was the final straw.
Several high-profile retailers have called in their advisers to restructure their businesses and the list of retail and leisure operators filling for administration (including Cath Kidston, Oasis, Laura Ashley, Debenhams and Carluccio’s) continues to grow. Total returns were -4.7% and -4.9% for the retail and leisure sectors respectively, following a 6% quarterly decline in capital values across the sectors in the first quarter.
Office occupational conditions softened over the quarter as the UK’s workforce were forced to embrace remote-working. Central London office take up declined by 34% over the quarter to 2.4m sqft in Q1, while availability rose to its highest level since Q4 2018, at 13.9m sqft, according to CBRE. All Offices total returns were 0% on the MSCI Monthly Index in Q1, down from 1.5% in Q4.
Conditions in the industrial sector were more robust as the lockdown measures produced a surge in the demand for online retail goods and a pick-up in the demand for logistics and industrial space from online retailers and supermarkets seeking short-term space solutions. According to CBRE, logistics take up rose from 5.4m sqft to 6.3m sqft over the quarter and availability continued to tick down (from 27m sqft to 25.7m sqft). As a result, the industrial sector posted another quarter of positive returns (0.5%), outperforming all other main-use sectors.
UK investment volumes totalled £12.9bn was in the first quarter of 2020, according to Lambert Smith Hampton’s UKIT Transactions report, Q1’s total was 14% ahead of the volumes recorded in the same quarter a year ago but 7% below the five-year quarterly average. However, Q1’s deal flow was skewed by the acquisition of the iQ student accommodation portfolio by Blackstone for £4.7bn, which if omitted would have meant Q1’s figure would be the weakest on record since mid-2012. All property sectors reported lower investment volumes in Q1, retail volumes fell to a record low of £605m compared to £0.9bn in Q4, industrial investment was down 58% on the previous quarter, while office volumes fell from £5.7bn in the Q4 to £3.9bn in Q1. But despite the disturbance to investment activity from Covid-19, appetite for UK property, particularly from overseas investors remained plentiful, with this buyer group accounting for 68% of the investment volumes in Q1.
Near term prospects will be challenging for commercial property with capital values expected to decline by 14% in 2020, which combined with a c.5% All Property income return could result in a -10% total return for the year. However, with the consensus view amongst economists that the disruption to economic activity from the virus will be brief (and contained to 2020 only) property returns should recover in 2021. We predict a 2% fall in All Property capital values in 2021 followed by a 5% recovery in values the year after resulting in All Property total returns averaging 2.7% p.a. over the five years to 2024. Our sectors views remain unchanged over the quarter, with supermarkets and the standard industrial sectors expected to offer the best risk-adjusted returns over the forecast period.