ESTATE ... Q1 2000 Q1 2010 Q1 2008 Q1 2006 Q1 2004 Q1 2002 Q1 2012 Q1 2014 Q1 2016 Q1 2018 Ongoing...
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UK Real Estate Market Outlook For Investment Professionals only
• Healthy economic activity underpinned by consumer sector and ongoing labour market strength
• Brexit uncertainty continues as UK government mulls over UK-EU deal
• Structural change continues to boost the industrial sector
• Flexible office space providers advancing regional take-up
• We believe ‘Destination’ retail well placed to weather the current turbulence
• Demand, diversification and defensiveness: Alternatives continue to appeal to investors
Inflation has also continued to edge downwards, having peaked at around 3% at the end of 2017. Now broadly in line with the Bank of England’s target, at 2.1% (December 2018), price pressures are expected to ease further in the short term. This should ensure that the path towards interest rate normalisation remains slow and steady. There is, however, significant uncertainty surrounding both expected price growth and any ensuing interest rate movements in the face of Brexit.
Overall, the UK economy looks to be in relatively good shape, with any weakness largely attributable to the uncertainty caused by the Brexit negotiations. If a Brexit deal is agreed, greater clarity around the future UK-EU relationship and a move towards the transition period should help to unlock some of the current economic standstill, particularly in terms of investment, boosting short term GDP growth.
Brexit uncertainty continues
The end of Autumn saw some progress made by Theresa May and her government on the road to Brexit, with the approval by EU leaders of a Withdrawal Agreement and a draft Political Declaration focusing on future UK-EU relations. However, Parliament voted against the deal and, at the time of writing, negotiations relating to the future path of Brexit were still ongoing in the House of Commons.
With the initial proposals rejected, what seemed like a fairly simplistic ‘Deal or No Deal’ situation has instead become a wider range of options, from a renegotiated Deal to delaying the date we leave the EU or even to the possibility of a second Referendum. What has become clear though is that the majority of MPs on both sides of the political divide are against a No Deal scenario. This will hopefully lead to increased co-operation and therefore a solution to the current stand-off.
If negotiations do succeed, this would likely be positive for economic stability. The consensus view is that the adoption of a deal will lead to stronger short term economic growth, as investment and spending decisions that had previously been put on hold are put into action.
The UK economy: continued resilience in the face of ongoing uncertainty
While the headlines have been dominated by doom and gloom stories relating to the UK-EU Brexit negotiations over the past six months, the UK economy itself has proven to be remarkably resilient, growing by 0.6% in the third quarter; its fastest pace of growth for almost two years.
Figure 1: Third quarter bounce back in GDP growth
Source: ONS, November 2018.
The labour market remains strong, with employment still at a record high and unemployment close to a 45-year low. With joblessness at a very low level, employers are finding it increasingly difficult to fill positions so the number of job vacancies is at its highest since records began in 2001. This is starting to feed through into pressures on earnings. As a result, wages are rising by 3.2% pa, the highest rate of growth since late 2008. Wages are also rising in real terms – something that will help to underpin consumer spending and consumer confidence levels.
Figure 2: Job vacancies hit new high
Source: ONS, November 2018.
Quarter-on-quarter growth Year-on-year growth
s ( 00
Brexit, what Brexit? Property fundamentals continue to underpin performance
The UK property market has continued its cyclical slowdown in recent months, with total returns now in the single digits (MSCI All Property 7.5% pa, December 2018) and likely to ease further in the next few months. In large part this reflects the shift from yield compression being the main driver of performance to income return accounting for the bulk of total returns.
While more muted economic growth and Brexit uncertainty is driving part of this deceleration in aggregate, looking beyond the All Property average indicates that sector-specific fundamentals are leading to very different stories being played out across the different markets.
Figure 3: Long term demand shifts driving short term performance
Source: MSCI, December 2018.
Long term trends are driving current performance, with the industrial sector still seeing the strongest performance, backed by ongoing structural change. Meanwhile Alternative sectors (such as residential, hotels, healthcare and leisure) are also outperforming, underpinned by factors such as demographic change. In contrast, retail, where future rental fundamentals appear more challenging, continues to weaken on average.
I t ot
s ( %
Retail Office Industrial Residential Hotel Other
Retail polarisation continues
With retailer retrenchment ongoing and CVA*s grabbing the headlines, occupier demand and rental growth remain weak. Average rents are now falling across the various retail types, exacerbated by the fact that there are now twice as many stores opening as closing. Undeniably, the current retail story is one of adversity, yet it is important to note that some parts of the market are more future-proofed than others.
Figure 4: Retailers drawn to quality, not quantity
Source: PMA, November 2018.
The retail story is increasingly one of divergence and polarisation. Quality remains a major factor in terms of occupier demand and thus rental performance, with prime retail generally holding up better in terms of vacancy, while more average property is suffering to a greater extent. In addition, locations with supportive demographics, that are well located and accessible with ‘destination’ appeal, are likely to better weather the current turbulence in the retail sector. Likewise, retail parks close to good transport routes that can use click and collect to attract customers are also positioned for future success.
Town Centre Vacant Units (%)
Town Centre Prime Vacant Units (%)
-5 0 5 10 15 20
All Major Cities' Average All Regional Centres' Average
Manchester Oxford Derby
Kingston-upon-Thames City of London
*Company Voluntary Arrangement
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Industrial: addressing the supply/demand imbalance
The industrial occupier market continues to thrive, with rental growth at 1.1% on a three-month basis (MSCI, December 2018). The expansion of logistics and distribution networks, driven by structural change, shows no sign of abating and even retailers that are otherwise reducing their retail footprint continue to invest in industrial units. From a demand perspective, therefore, conditions seem little changed.
It is instead on the supply side that things are starting to alter. Increasingly, we see signs of a wave of speculative development, albeit focused on Big Boxes rather than multi-lets. This has taken volumes of speculative space under construction to post-Global Financial Crisis highs. Much speculative space is being focused at the larger end of the market, yet demand is focused on smaller units in London and the South East, which means there is a growing threat of a future supply