2015 real estate market outlook september uk · and acenden) thanks to the improving connectivity...
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Part of the M&G Group
Real Estate Market Outlook UK
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UK economy positioned well for
further healthy growth
The UK is set to be the fastest growing member of the
G7 group of major advanced economies for a second
year in row, with consensus forecasts pointing to a 2.6%
rise in real gross domestic product (GDP) in 2015.
Unemployment, at 5.6%, has fallen to levels last seen
before Lehman Brothers collapsed in 2008. In addition,
real wage growth is accelerating and consumer prices
are stable. The Misery Index, which sums the rates of
unemployment and inflation, is running at its lowest
level for decades. This is good news for households,
who have more spending power and more assurance
over income.
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Fig 1: Misery Index lowest in almost half a century
Source: Experian Economics, BoE, ONS, June 2015.
Executive summary
• UK on track to post highest economic growth in the G7 for second year in a row
• Property continues to offer historically very attractive yield premium versus bonds despite recent market moves
• Vacancy rates falling across the three major commercial sectors
• Rental growth has surged to pre-crisis rates and expected to pick up further
• Top investment opportunities: Greater London residential, South East offices
• Sector to watch for late recovery potential: regional
retail
6% rental growth forecast for
South East offices in 2015
36% rise in first half transaction
volumes versus 2014
3rd year of double-digit property
returns expected in 2015
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Consumer confidence Historic average
Fig 2: Consumer confidence highest since the 1990s
Source: Bloomberg, June 2015.
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Virtuous circles are taking shape in the UK economy as
the impressive job creation is supporting households and
boosting economic demand, which then fuels business
confidence, spurring the creation of more jobs. The stage
is set therefore for improving occupier demand in all the
main property sectors, and across the country.
As a result, consumer confidence is now the highest
since the 1990s. This brighter picture has helped to
push retail sales volumes up by more than 4% over the
last year.
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Strong prospects for occupancy
and rental growth
Buoyed by the favourable economic environment, take-
up of space is healthy and tenant demand is set to
increase further. Central London continues to see very
strong conditions – high business confidence has driven
office take-up to an annual rate of over two million
square feet, while retailers are taking quality pitches at
ever-increasing rents.
The momentum is cascading out to the South East
markets and the major regional cities. This has been
most pronounced in the office and industrial/logistics
sectors, with a slower recovery in retail.
Across the sectors, construction rates have held
significantly below historic averages since at least 2010.
The combination of improving demand and lack of
supply has helped vacancy rates to fall.
Regional offices and retail face many more years of
limited supply, providing ongoing support for rents.
Construction is coming back for central London offices,
however, and to a lesser degree in the industrial sector.
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Central London offices Historic average (1988-2014)
Fig 3a: Central London office construction coming back
Source: CBRE, June 2015.
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Regional offices Historic average (1988-2014)
Source: PMA, June 2015.
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Fig 3b: Regional office development pipeline subdued
For the property market as a whole, average rents are
now rising at a similar pace to that seen in 2006-7,
before the financial crisis. We expect rental growth
to increase further over the course of the next year
as economic growth continues to support business
investment activity.
We see the all property average rate of rental growth
surpassing 4% in 2015. Digging beneath this average,
some markets will perform even better, such as central
London where we anticipate double-digit growth for
offices and close to 10% for shops. Indeed, we expect
new record rent levels to be hit in central London during
this growth cycle. In addition, we forecast that rental
growth for offices in the rest of London and the wider
South East will exceed 6%, with some selected markets
reaching record highs.
The South East office markets are increasingly attracting
business occupiers from central London (such as Maersk
and Acenden) thanks to the improving connectivity and
considerably lower rents. Out in the regional markets,
take-up continues apace for both city centre and out
of town offices following exceptionally strong occupier
demand at the end of 2014. Corporates currently have
an extensive requirements list for space, suggesting
strong rental growth to come.
Industrial fundamentals have gone from strength to
strength, with demand coming from a broad occupier
base. Take-up is particularly healthy on the retail-
orientated distribution side and availability of space is
falling, especially at the prime and good secondary end.
Almost all of the industrial space that was constructed
in the previous cycle is now leased, including assets in
non-core locations, and speculative development has
started to return. Much of this pipeline is in the core
markets of the South East and the Midlands where
demand is strongest, with little else currently planned
for the rest of the country. With availability tight and
occupier demand strong, rental growth has broadened
out beyond prime and is expected to remain strong over
the near to medium term.
We forecast that rental growth for
offices in the rest of London and
the wider South East will exceed
6%, with some selected markets
hitting record highs.
“ “Across the sectors, construction
rates have held significantly
below historic averages since at
least 2010. “ “
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In the retail sector, London remains the strongest
location, but green shoots of rental growth are now
visible in the South East. Some retailers are planning
expansion, including new market entrants such as Pep
& Co who intend to launch a physical-only presence.
Relaxed Sunday trading laws announced in the July
budget should also help. Shopping centres, on average,
continue to see marginal rental declines due to high
void levels. More generally, leisure accounts for an
increasing proportion of retail-related take-up.
The long-awaited cyclical upswing in retail conditions
is, nevertheless, starting to come through thanks to
the resurgence in consumer confidence and spending.
This, along with muted construction, should support
retail rents over the medium term.
In the residential sector tenant demand is strong, against
the backdrop of robust economic growth and improving
real earnings. Tighter mortgage regulation and a lack of
new stock has helped to underpin rents. We expect the
highest rental growth in London and the South East, as
these have the greatest supply/demand imbalance. At
the regional level, larger cities with stronger employment
growth should perform the best. Robust demographics
support long-term prospects for the sector, with the
population forecast to grow by 7% over the next decade
in England and by 13% in London.
Compelling returns on offer
Since capital values troughed in June 2009, the IPD
Quarterly Total Return Index has doubled, giving
commercial real estate investors a 100% return.
However, average capital values remain almost 20%
below pre-financial crisis peaks hit in mid-2007, leaving
scope for future growth.
Appetite for UK bricks and mortar remains strong
from both domestic and foreign investors, despite a
phenomenal past 12 months for inflows – and it is not
difficult to see why. In addition to steadily strengthening
fundamentals, property yields are still considerably
higher than those available from bonds. The spread
remains comfortably in excess of long-term historic
averages, even though property yields have moved
in materially since 2013. An income return from UK
property above 5% is very compelling for investors who
have weathered the very low bond yield environment of
recent years.
As risk appetite expands, alongside an increasingly
broad-based and sustained economic resurgence, we
believe investors will put more money into higher-yielding
secondary property. It is this section of the market which
arguably has the most potential for yield compression.
This said, investors remain rightly cautious over the
truly risky assets at the weaker end of the spectrum,
particularly in the retail sector.
Yield compression is increasingly being supplemented
by rental growth to make up overall capital performance,
particularly in the prime end.
Overall, we see the twin engines of buoyant investment
volumes and robust economic growth driving continued
strength for property. We expect 2015 total returns to
surpass 14%, followed by another double-digit return
next year – the fourth in a row.
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Spread prop EY above gilts Average spread prop EY above gilts
Spread prop EY above corps Average spread prop EY above corps
Spread prop IY above gilts Average spread prop IY above gilts
Spread prop IY above corps Average spread prop IY above corps
Fig 4: Spreads of property yields over both government
and corporate bond yields remain above historic averages
Source: IPD Monthly Index, Bloomberg, June 2015.
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M&G Real Estate’s rental growth projections for next two years
Top 3 segments Bottom 3 segments
Central London Offices
Central London Shops
Rest of London & South East Offices
Supermarkets
Retail Warehouses
Regional Shops
An income return from UK property
above 5% is very compelling for
investors who have weathered the
very low bond yield environment of
recent years.
“ “
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Potential risks on the horizon include interest rate rises, a
pending in/out referendum on Europe and the potential
for a re-escalation of issues in the eurozone.
Top three investment opportunities
1. Short-term value: South East offices
Offices outside of central London offer scope for further
yield compression and relatively strong rental growth.
Regional offices should not to be overlooked as they
also offer good medium-term return prospects, albeit
with fundamentals lagging a little.
2. Strong medium-term prospects: residential
Over the medium term, we believe that the residential
sector offers the most interesting value. For the 25 to
34 year old demographic, despite record low interest
rates, renting remains the most affordable – and most
likely – option.
On balance it currently feels more like a 1993-style
strong recovery for UK real estate, as opposed to
the debt-fuelled boom of the mid-2000s or the late
‘80s boom characterised by construction and over-
development. Looking ahead, therefore, we expect
returns to moderate from the current very strong levels
beyond 2016 and to come back to earth with a relatively
smooth landing, more akin to the post-1993 period rather
than the sharp corrections of 1990-92 and in 2007-09.
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Fig 5: Stage is set for further strong (but more sustainable)
performance following an exceptional 2014
Source: IPD Annual Index, M&G Real Estate forecast, July 2015.
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In the short term, Greater London and the South East
area, which benefit from strong fundamentals and
good transport links, offer the best returns. Elsewhere
in the country, a more selective approach is required,
focusing on economically strong cities such as Bath
and Bristol.
Despite government initiatives to increase
homeownership and proposed reforms to the planning
system, the lack of housing construction points to
additional upwards pressure on rental growth as well
as capital appreciation. Residential prices outside of
London are still well below their pre-crisis levels in real
terms, and the medium to long-term prospects, in our
view, look favourable.
3. One to watch for recovery potential in the
medium-term: retail
The retail sector is beginning to offer relative value in a
selective and gradual fashion. Investors must be wary of
covenants as well as the wide divides within the market
(both geographically and otherwise – there is a huge gulf
between the best assets and the worst).
On aggregate we expect retail to underperform in
the near term, but a catch-up is already on the way,
driven partly by cyclically improving fundamentals, and
by investors seeking relative value after bidding down
yields elsewhere. The value on offer in high street retail
is underscored by the comparison with distribution
warehouses which for the first time ever are yielding
less than shops.
Within retail, investors would generally be advised to
stick more closely to prime assets as, unlike in offices
or industrials, the higher yields available for secondary
stock are frequently insufficient to compensate for the
poor fundamentals and the risks.
We expect 2015 total returns to
surpass 14%, followed by another
double-digit return next year –
the fourth in a row.“ “
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Fig 6: Regional shops yielding more than logistics for
the first time ever
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Jun 15’
Regional shops Distribution warehouses
Source: IPD Annual Index, IPD Quarterly Index.
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In conclusion
UK real estate is on track for a third year of double-
digit returns, following a strong first half in terms of
both performance and investment volumes. We believe
that sustained economic growth and investor appetite
will support pricing and that yields will continue to
compress, albeit at a more modest pace than seen since
late 2013. Crucially, the occupier market is gathering
momentum, particularly outside of London. The robust
rental growth that is now feeding through, supported
by below-average construction, will help to drive returns.
While London should continue to perform well in the
short term, from a value perspective we expect to see
considerable investor demand in the regions over the
coming years. At the moment, there are particularly
attractive investment opportunities in South East offices
and the residential sector. Investors who are willing to
look beyond the short term, meanwhile, could find value
in the retail sector where the first signs of recovery are
starting to come through.
The Renaissance, Croydon. An example of an office
outside of central London that has good investment
performance prospects ahead.
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IMPORTANT INFORMATION: For investment professionals only. The value of investments can fall as well as rise. This article reflects M&G Real Estate’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this article does not constitute an offer or solicitation. It has been written for informational and educational purposes only and should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of Professional Client as defined in the Handbook published by the UK Financial Conduct Authority. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G Real Estate does not accept liability for the accuracy of the contents.
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