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COMMERCIAL PROPERTY EXAMINER

QUARTER TWO | 2019 Cluttons Investment Management Commercial property examiner | Q2 2019

We invest in best in class properties for their quality, income security and sustainable growth potential. We believe that a portfolio of properties demonstrating these attributes will produce a consistent, superior investment return over time.

PORTFOLIO We blend incisive, value-add research with disciplined portfolio construction, selecting those sectors with the best long-term performance prospects.

PERFORMANCE Our philosophy is perfectly aligned with our clients’ objectives as long-term investors in property and best illustrated in our track record of benchmark outperformance over one, three or five year or longer-term time horizons.

ASSET Our portfolio management is underpinned by a rigorous approach to individual stock selection, with active asset management to protect and enhance asset value whilst driving investment returns.

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EXECUTIVE SUMMARY

The UK economy shrunk by 0.29% in April Rental value growth for South East Industrials and although it recovered most of the lost is weakening but it is still strong by historical ground in May, July’s Markit/CIPS PMI survey standards. However, rental values for signals an easing in the rate of economic Shopping Centres, Retail Warehouses and growth from 0.4% in Q1 to 0.2% in Q2. Shops have decreased sharply.

Market interest rate expectations are not May’s IPF Consensus forecast round continues indicative of any further rise in base rates to indicate that 2019 is expected to represent until the end of 2021. Indeed Gertjan Vlieghe a cyclical trough. of the MPC has suggested that rates could be reduced to “near-zero” in the event of a All Property performance expectations for no-deal Brexit. 2019 weakened from 2.4% to 1.8% and expectations for were reduced to 3.1% from Gilt yields have hardened by a further 40 bps 3.5% in February. Capital values are now since the end of Q4 in response to recent expected to shrink by 2% or more in both reductions in consumer price inflation and 2019 and 2020. the subdued outlook for the economy. The current pricing of UK real estate remains In the medium to long-term we continue to attractive relative to other asset classes. expect the UK’s exit from the EU to entrench the current slow-down in economic growth The forward looking public real estate markets that will restrain rental growth and cause indicate that private direct property investors yields to soften. Consequently, we expect a should be looking to sell down their exposure gradual weakening in property values over the to retail and buy student accommodation, next three years; with an average annualised healthcare and logistics assets. total return 4% that is some way below the long-run average in this cycle of 10%. MSCI data indicates that All Property values contracted in Q2 for the third consecutive quarter. The capital values of all retail segments are falling. Only Industrials are benefitting from an uplift in capital values.

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MICRO-ECONOMIC BACKGROUND

GVA Chart 1.1 Economic growth - rolling 12m Chart 1.2 Bank of England economic forecast (May 2019) Chart 1.3 Historic and forecast economic growth rates

UK economic output has been disappointing 5% 2.50 3.00 since the Global Financial Crisis (GFC). Since 4.5% 2.25 2.50 June 2009 the economy has grown at an 4% 2.7 annualised rate of just 1.8%. Forecaster 3.5% expectations of the outlook for the next two 2.00 2.00 3% years are lower still. 1.8 2.5% 1.75 1.50 1.6 2% The UK economy shrunk by 0.29% in April and 1.4 1.50 1.00 1.3 although it recovered most of the lost ground 1.5% in May, July’s Markit/CIPS PMI survey signals 1% 1.25 0.50 an easing in the rate of economic growth from 0.5%

0.4% in Q1 to 0.2% in Q2. 0% 1.00 00 MAY MAY MAY MAY MAY MAY MAY MAY MAY MAY JUN SEP DEC MAR JUN SEP DEC MAR JUN SEP DEC MAR JUN PRE GFC POST GFC BOE TREASURY OBR 10 11 12 13 14 15 16 17 18 19 19 19 19 20 20 20 20 21 21 21 21 21 22 A similar economic shock in 2008 – 09 Source: National Statistics (ONS) Source: Bank of England (BoE) Source: ONS, BoE, HM Treasury & Office of Budget Responsibility (OBR) resulted in the commercial property values declining 40%.

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MICRO-ECONOMIC BACKGROUND

CPI Chart 1.4 CPI -rolling 12m Chart 1.5 Bank of England CPI forecast (May 2019) Chart 1.6 Market interest rate expectation (May 2019)

Consumer Price Inflation is currently 2.0% 6% 2.25 1.25 year-on-year; right on the MPC’s target inflation rate of 2.0%. Weak economic growth forecast 5% for the next 2-years means that inflationary pressures will be relatively subdued. 4% 2.00 1.00

There is a possibility that a further fall 3% in the value of sterling could provide an 2% 1.75 0.75 inflationary spike through higher prices for imported goods. But when sterling fell 20% 1% after the 2016 referendum result, the MPC was prepared to look through the resulting 0% 1.50 0.50 MAY MAY MAY MAY MAY MAY MAY MAY MAY MAY JUN SEP DEC MAR JUN SEP DEC MAR JUN SEP DEC MAR JUN JUN SEP DEC MAR JUN SEP DEC MAR JUN SEP DEC MAR JUN inflationary spike. 10 11 12 13 14 15 16 17 18 19 19 19 19 20 20 20 20 21 21 21 21 21 22 19 19 19 20 20 20 20 21 21 21 21 21 22

Source: ONS Source: BoE Source: BoE Market interest rate expectations are not indicative of any further rise in base rates until the end of 2021. Indeed Gertjan Vlieghe of the MPC has suggested that rates could be reduced to “near-zero” in the event of a Chart 1.7 UK city economies Chart 1.8 UK city economies excl. 1 Chart 1.9 UK city economic growth (2013-17 annualised) no-deal Brexit. 4% 3.5%

REGIONAL GVA 3% The UK’s economy is dominated by London. 2.5% The UK’s capital city is larger than the next 2% ten largest UK cities combined and has 1.5% experienced the strongest economic growth 1% of any UK city in the last 5 years. 0%

-1%

Analysis of City level economic data allows -2% Cluttons IM to closely target their tactical LEEDS LEEDS LEEDS BELFAST BELFAST BRISTOL BRISTOL BELFAST CARDIFF CARDIFF BRISTOL DUNDEE CARDIFF

asset allocation decisions. LONDON LONDON SWANSEA SHEFFIELD SHEFFIELD ABERDEEN SHEFFIELD GLASGOW GLASGOW GLASGOW LIVERPOOL LIVERPOOL LIVERPOOL CAMBRIDGE EDINBURGH EDINBURGH NEWCASTLE EDINBURGH BIRMINGHAM BIRMINGHAM MANCHESTER MANCHESTER BIRMINGHAM MANCHESTER MIDDLESBROUGH

Source: ONS Source: ONS Source: ONS [email protected] cluttonsim.com | 5 Cluttons Investment Management Commercial property examiner | Q2 2019

INVESTMENT MARKETS

INTEREST RATES & YIELDS Chart 2.1 FT GILT 5-15 year yield Chart 2.2 Property IY - GILT yield gap Chart 2.3 Asset yields(Jun 2019)

The prevailing low interest rate environment 5% 5% BASE RATE 0.8 has inflated prices across the asset classes. 4.5% 4.5% But at the All Property level capital values are 4% 3M LIBOR 0.8 still below the peaks achieved in mid-2007. +1stdev 3.5% 4% FTA 5-15Y GILT 0.8 3% Gilt yields have hardened by a further 40 bps 3.5% mean 2.5% MSCI PROPERTY FUNDS 2.7 since the end of Q4 in response to recent 3% reductions in consumer price inflation and the 2% -1stdev 3.2 subdued outlook for the economy. The current 1.5% 2.5% FTSE 250 property initial / gilt yield gap has therefore 1% 2% FTSE 100 4.3 increased to 4.23 % which is more than one 0.5% standard deviation above the 10-year average. 0% 1.5% MSCI ALL PROPERTY 5.1 JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN The gap has widened by 80 basis points since 9 10 11 12 13 14 15 16 17 18 19 9 10 11 12 13 14 15 16 17 18 19

September last. Source: Financial Times (FT) Source: FT, MSCI & APR Source: FT & MSCI

The current pricing of UK real estate remains attractive relative to other asset classes.

PUBLIC REAL ESTATE PRICING Chart 2.4 FTSE Reit Nav discount Chart 2.5 Discount/Premium to NAV by country (Jul 19)2 Chart 2.6 Discount/Premium to NAV by country (Jul 19)3 80 It is not uncommon for shares in European 10% 40 public real estate companies to trade at a 30 60 5% price that reflects a discount to NAV. 20 40 0% 10 20 In the UK the widening discount to NAV of -5% 0

Reits suggests that investors are wary of 0 -10% -10 current domestic property valuations. -20 -15% -20 -30 Land Securities and , with -20% -40 portfolios of Central London Offices and -40 -25% -60 Shopping Centres; and specialist Shopping -50

Centre Reits, and have a -30% -60 -80

JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN ESP PHP BYG SHB BEL CHE SWE AUT FIN NOR DEU ESP EURO FRA GBR NLD ITA LMP DLN NRR UTG WKP SAFE DIGS INTU THRL CAPC BLND BBOX LAND SGRO market capitalisation that is at a discount of 9 10 11 12 13 14 15 16 17 18 19 GPOR HMSO

40% or more to the net value of assets in Source: European Public Real Estate Association (EPRA) Source: EPRA Source: EPRA their portfolios. [email protected] cluttonsim.com | 6 Cluttons Investment Management Commercial property examiner | Q2 2019

INVESTMENT MARKETS

Chart 2.7 FTSE Reit 12m total return Chart 2.8 EPRA 12m total return (Jun 19) Chart 2.9 UK Reits 12m price change (Jul 19) 30 PUBLIC REAL ESTATE PERFORMANCE 80% 30.00 UK Reits are currently near the bottom of the 20 60% 20.00 EPRA performance tables. 10

40% 10.00 0

Stronger share price growth has come from -10 those companies specialising in Healthcare, 20% 0.00 -20 Student Accomodation and Logistics. Those -10.00 0% -30 focused on Central London Offices or Shopping -20.00 -40 Centres have seen their share prices fall in the -20% -50 last 12 months. Hammerson and Intu by more -30.00 -40% -60 than 50%. UK ASIA ITALY EURO JAPAN WORLD -60% FRANCE -70 GERMANY AUSTRALIA N. AMERICAN. ESP PHP UTP

JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN JUN BYG SHB LMP DLN NRR WKP SAFE DIGS INTU THRL CAPC

The forward looking public real estate markets BLND BBOX LAND SGRO GPOR 9 10 11 12 13 14 15 16 17 18 19 NETHERLANDS HMSO indicate that private direct property investors Source: FT Source: EPRA Source: FT should be looking to sell down their exposure to retail and buy student accommodation, healthcare and logistics assets.

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COMMERCIAL PROPERTY MARKET PERFORMANCE

MSCI DATA COMMENTARY - PT. 1 Chart 3.1 Total returns by sector Chart 3.2 Total returns (Q2 annualised)

The performance of private real estate as 160 35 CL Shops monitored by MSCI is weakening across all 30 SE shops 150 sectors of the market. 25 RUK shops

20 Shopping Centres 140 15 MSCI data indicates that All Property values Retail Warehouse 10 contracted in Q2 for the third consecutive 130 City offices 5 quarter. However, the rate of capital value Mid & WE offices 0 growth as measured by the MSCI Monthly 120 RoSE offices

-5 Rolling 3m (annualised %) index improved slightly from - 0.8% in Q1 RUK offices

Index value (shared area) (shared Index value 110 -10 SE Industrial to -0.7% in Q2. -15 RUK Industrial 100 -20 The capital values of all retail segments JUN JUN JUN JUN JUN JUN All property 14 15 16 17 18 19 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 including Central London Shops are falling. All property index All property Retail Office Industrial Only Industrials are benefitting from an uplift Source: MSCI Jun 19 Source: MSCI Jun 19 in capital values.

MSCI DATA COMMENTARY - PT. 2 Chart 3.3 MRV growth by sector Chart 3.4 MRV growth (Q2 annualised)

All UK property rental value growth continues 114 12 CL Shops to slow. Growth decreased to a barely 10 SE shops 112 perceptible 0.2% in the year to June from 8 RUK shops

0.3% in the year to March. 110 6 Shopping Centres

4 Retail Warehouse 108 Rental value growth for South East 2 City offices 106 Industrials is weakening but it is still strong 0 Mid & WE offices by historical standards. -2 RoSE offices

104 Rolling 3m (annualised %) RUK offices -4 Index value (shared area) (shared Index value 102 SE Industrial However, rental values for Shopping Centres, -6 RUK Industrial Retail Warehouses and Shops have 100 -8 decreased sharply. JUN JUN JUN JUN JUN JUN All property 14 15 16 17 18 19 -8 -6 -4 -2 0 2 4 6 All property index All property Retail Office Industrial

Source: MSCI Jun 19 Source: MSCI Jun 19

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COMMERCIAL PROPERTY MARKET PERFORMANCE

Chart 3.5 Initial yield by sector MSCI DATA COMMENTARY - PT. 3 Chart 3.6 Yield impact (Q2) 3.7 TOTAL RETURNS The Q2 market decline is wholly attributable 6.5 CL Shops June 3m 6m 12m to yield impact of -0.6% as there was no SE shops All property 0.2 0.6 1.1 4.0 Rental Value Growth to speak of at the All 6.0 RUK shops Retail -0.5 -0.9 -2.2 -3.9 Property level. Shopping Centres Office 0.3 0.9 2.1 5.8 5.5 Retail Warehouse The initial yield on MSCI’s monthly index has City offices Industrial 0.6 1.7 3.5 10.8 increased from 5.02% in Q1 to 5.06% at the 5.0 Mid & WE offices ANNUALISED end of Q2. RoSE offices All property 2.0 2.5 2.3 4.0

4.5 RUK offices

Index value (shared area) (shared Index value Retail -5.8 -3.6 -4.3 -3.9 SE Industrial Office 3.4 3.8 4.2 5.8 RUK Industrial 4.0 Industrial 7.7 7.0 7.0 10.8 JUN JUN JUN JUN JUN JUN All property 14 15 16 17 18 19 Source: MSCI Apr19 -3.0 -2.5 -2.0 -1.5 -1.0 -0.5 0.0 All property index All property Retail Office Industrial

Source: MSCI Jun 19 Source: MSCI Jun 19

3.8 CAPITAL GROWTH 3.9 INCOME RETURN 3.10 ERV GROWTH 3.11 NET INITIAL YIELD June 3m 6m 12m June 3m 6m 12m June 3m 6m 12m June 3m 6m 12m All property -0.3 -0.7 -1.4 -1.2 All property 0.4 1.3 2.6 5.2 All property 0.0 0.1 0.1 0.2 All property 5.1 5.0 4.9 5.0

Retail -1.0 -2.4 -5.1 -9.5 Retail 0.5 1.6 3.1 6.1 Retail -0.3 -0.8 -1.9 -3.9 Retail 6.0 5.9 5.8 5.7 Office -0.1 -0.2 -0.3 1.0 Office 0.4 1.2 2.3 4.7 Office 0.1 0.4 0.9 1.9 Office 4.6 4.5 4.4 4.5 Industrial 0.2 0.5 1.1 5.8 Industrial 0.4 1.2 2.4 4.8 Industrial 0.3 0.8 1.5 3.4 Industrial 4.5 4.5 4.4 4.6 ANNUALISED ANNUALISED ANNUALISED Source: MSCI Apr19 All property -3.2 -2.6 -2.8 -1.2 All property 5.3 5.3 5.3 5.2 All property 0.4 0.3 0.2 0.2 Retail -11.5 -9.4 -10.0 -9.5 Retail 6.4 6.4 6.3 6.1 Retail -3.1 -3.3 -3.7 -3.9 Office -1.2 -0.9 -0.5 1.0 Office 4.7 4.8 4.7 4.7 Office 0.7 1.6 1.8 1.9 Industrial 2.9 2.1 2.2 5.8 Industrial 4.8 4.8 4.8 4.8 Industrial 4.1 3.3 3.1 3.4

Source: MSCI Apr19 Source: MSCI Apr19 Source: MSCI Apr19

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COMMERCIAL PROPERTY MARKET OUTLOOK

IPF CONSENSUS FORECASTS MAY 2019 Chart 4.1 IPF All Property forecasts y-by-y (May 19) Chart 4.3 IPF 2019 forecasts by sectors (May 19)

May’s forecast round continues to indicate that 7.6 7.2 2019 is expected to represent a cyclical trough. 5.2 5.6

All Property performance expectations for 2019 4.4 3.5 3.1 weakened from 2.4% to1.8% and expectations 2.4 1.9 1.8 for 2020 were reduced to 3.1% from 3.5% in 1.7 1.5 1.7 4.0 February. Capital values are now expected to 3.1 shrink by 3% in 2019 and 2% in 2020. -1.1 -1.0 At the segment level the outlook for 1.8 -3.2 -3.2 retail property in the next 12 months has -3.4 weakened further. The outlook for Offices and -5.8 FEB-19 MAY-19 Industrials is stronger. 2019 2020 2021 2022 2023 5-YEARS

Source: IPF May19 Source: IPF May19 The 5-year outlook has weakened to an annualised average forecast of 4.0% in May from 4.4% in February.

CLUTTONS IM HOUSEVIEW FORECASTS Chart 4.2 IPF forecast evolution (May 19) Chart 4.4 IPF 5-year forecasts by sectors (May 19) 5 In the medium to long-term we continue to 6.2 FEB-19 MAY-19 expect the UK’s exit from the EU to entrench 5.7 the current slow-down in economic growth 4 that will restrain rental growth and cause 4.5 4.3 4.4 4.1 4.0 yields to soften. 3.8 3.8 3.9 3.8 2020 3 3.0 Consequently, we expect a gradual weakening 2.9 in property values over the next three years; 2.1 2.1 with an average annualised total return of 2 2019 4% that is some way below the long run of 1.0 average in this cycle of 10%. 1 MAY AUG NOV FEB MAY 18 18 18 19 19

Source: IPF May19 Source: IPF May19 [email protected] cluttonsim.com | 10 Cluttons Investment Management Commercial property examiner | Q2 2019

COMMERCIAL PROPERTY MARKET OUTLOOK

CLUTTONS IM OPINION Chart 4.5 Cluttons house view - 2019 relative total returns (%) Chart 4.6 Cluttons house view - 2019-21 relative total returns (%)

Political and economic indicators suggest the Shopping Centres Shopping Centres prospects of a no-deal Brexit are greater now RUK shops RUK shops than they were 3 months ago, a recession Retail Warehouses Retail Warehouses and decline in capital values cannot therefore ROSE shops ROSE shops be discounted. Cent Lon shops Cent Lon shops

City of Lon offices Whilst some way below this cycle’s average, City of Lon offices an annualised total return of 4% p.a. over the All Property All Property next three years will compare favourably to West End offices West End offices both UK equities and gilts on a relative basis. RUK offices RUK offices ROSE offices ROSE offices Defensively positioned portfolios holding RUK industrials RUK industrials high quality stock on durable income profiles SE industrials SE industrials and with limited exposure to retail will Source: Alexander Property Research (APR) Source: APR Q219 perform best.

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GLOSSARY

1. LEEDS CITY REGION 2. BEL Belgium Barnsley CHE Switzerland Bradford SWE Sweden Calderdale AUT Austria Craven FIN Finland Harrogate NOR Norway Kirklees DEU Germany Leeds ESP Spain Selby EURO Europe Wakefield FRA France York GBR NLD Netherlands WEST MIDLANDS ITA Italy COMBINED AUTHORITY Birmingham 3. SAFE Ltd. Coventry BYG plc Dudley PHP Primary Health Properties Sandwell UTG Unite Group Plc Solihull LMP LondonMetric Property Plc Walsall SGRO Wolverhampton THRL Target Healthcare REIT Limited BBOX Tritax Big Box REIT GREATER MANCHESTER DIGS GCP Student Living plc COMBINED AUTHORITY ESP ESP Empiric Student Property Bolton WKP Plc Bury DLN Plc Manchester GPOR Plc Oldham SHB Rochdale CAPC Capital & Counties Properties PLC Salford NRR NewRiver REIT plc Stockport LAND Land Securities Group PLC Tameside BLND British land company Trafford HMSO Hammerson Plc Wigan INTU INTU Properties Plc [email protected] cluttonsim.com | 12 cluttonsim.com

For further details contact:

Jamie McCombe Simon Latham Head of investment management Non-executive chairman +44 (0) 20 7647 7234 +44 (0) 20 7408 1010 [email protected] [email protected]

Matthew Peake Ian Harvey Senior investment manager Consultant +44 (0) 20 7647 7067 +44 (0) 7590 111 314 [email protected] [email protected]

Researched on behalf of Cluttons Investment Management by Alexander Property Research (www.alexanderpropertyresearch.com)

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