eProspects In association with Volterra Consulting Q2 2010
Economy Update Property Update Post budget assessment House Price Outlook Financial Markets in Downturn Commercial Property Overview Inflation So where do we see the commercial China frees up its currency market going from here? Economy Update
Post budget assessment The main focus of the Budget was to bring the public nances under control. There are three aspects to this. First, the amount the government is borrowing in any given year. Second, the outstanding stock of debt. Third, the more esoteric but important concept of the ‘structural de cit’. In the 2009/10 nancial year, net government borrowing was a massive 11 per cent of GDP, getting on for £200 billion. The assessment by the independent Of ce for Budget “History suggest Responsibility (OBR) is that this will be reduced to just 1.1 per cent of GDP by 2015/16, with that once con dence a greater than 50 per cent chance of this being met earlier in 2014/15. returns and recovery Net borrowing in any one year is the addition to the existing stock of outstanding debt, which was also giving cause for concern. From a level of 53 per cent of GDP in 2009/10, the level of gets under way, GDP borrowing inherited from Labour will inevitably mean that this will rise in the short-term. The OBR estimate it will rise to a peak of 70 per cent in 2013/14, falling to 67 per cent by 2015/16. growth can easily A key criticism of Gordon Brown’s time as Chancellor is that he was in practice not prudent exceed 3 per cent but pro igate. The basic idea behind government borrowing is that when the economy is doing well, the government should run a surplus, to be able to nance the borrowings in bad a year” times such as the 2008/09 nancial crisis. Brown ran de cits, borrowed money, in the good times. The OBR reckon that George Osborn and the coalition government have cracked this problem. The ‘structural de cit’ will be eliminated by 2014/15. All this is good news. The main risk to the UK economy prior to the election was that long- dated gilt yields would rise to 6 per cent as a result of a lack of con dence in the state of the public nances. This would have had a devastating impact both on the economy as a whole and on commercial property in particular. In fact, long-dated gilt yields have remained around 4 per cent and the budget gives us con dence that this will persist. The overall economic forecasts are if anything too pessimistic. GDP is projected to grow by 1.2 per cent this year, followed by 2.3 per cent in 2011 and 2.8 per cent in 2012. History suggest that once con dence returns and recovery gets under way, GDP growth can easily exceed 3 per cent a year – as the example of the 1980s and 1990s shows following the recessions at the start of those decades. If this were to happen, the public nances would be strengthened even more. The main reason for the huge level of government borrowing is not the cost of ‘bailing out the banks’. Tax receipts by the government are very sensitive to the state of the economy. In a recession they collapse, in a strong recovery they rise quickly. The main potential downside to economic prospects is something we often raise, and that is the concern that individuals will start to save a lot to try to reduce their debts. The OBR has consumer spending rising slightly faster than personal incomes over the forecast period to 2015/16. If this trend proves incorrect and households save rather than spend, the overall growth rates for the economy will be weaker. Economy Update cont.
“PULL QUOTE Financial Markets in Downturn HERE”
“Global markets have all fallen by roughly 10% since April.”
Figure 1: Comparison of Major Indices Following on from the concerns about the future of the European economy, markets globally have been moving downward from a previous bullish increase. As the chart above shows, global markets have all fallen by roughly 10% in since April. This can be attributed to many things. In Britain the new coalition government has been seen to take serious action on the budget de cit which has helped restore some con dence in the UK’s ability to repay its debt. In Japan markets were made nervous by fears about the future demand of imports from Europe. In addition to market unrest the VIX index, a measure of nancial risk, reached its highest level in 14months. The housing market in London has historically been sensitive to movements in nancial markets, particularly where demand is driven by employees in the nancial and business services sector. In the UK the recovery is becoming more established and interest rates have remained low even though in ation is above target. Economy Update cont.
In ation 6.00% Forecast 5.00% “The reminbi was 4.00% undervalued against
3.00% the dollar by as much as 40 per cent.” 2.00%
1.00%
0.00%
-1.00%
-2.00% 2011 Jan 2011 2001 Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2012 Jan 2013 Jan 2014 Jan RPI CPI Threshold Figure 2: Comparison of Inflation from CPI and RPI As the monthly results from the ONS were published for April 2010 the news hit that in ation was up. The Retail Price Index (RPI) hit 5.3% and the Consumer Price Index (CPI), which the Bank of England targets, also rose to 3.7%. This is the highest rate since November 2008. Whilst part of this increase is due to food prices rising by 2.6% the major contribution to this number comes from the commodities market which is now coming down from a previous high. The effects of high futures prices will still be felt in the coming months. The price of fuel in the UK also rose by 25%. The increase in VAT and higher duty on alcohol and cigarettes also added to the higher in ation. The above graph shows how in ation has varied since 2001. The government initially decided to target in ation and keep it at a stable level of 2%. If actual in ation reaches 3.1% then Mervyn King must write to the Chancellor explaining why. Throughout 2010 in ation has been above the 3% threshold, further to that it has been above the 2% target in all but 6 of the past 30 months. This continued to be high in May with the CPI reaching 3.4% and RPI 5.1%. The Bank of England has been sighting temporary reasons for the high in ation. However these temporary reasons are persistently being used. The interesting thing to mention from this in ation is that it may help to reduce the debt in Britain. The high in ation also impacts upon savers, as with interest rates lower than in ation, the value of many savings will be falling in real terms.
China frees up its currency The announcement by the Chinese government to allow greater exibility in its currency is by far the most important economic event of the past week. There have been persistent complaints form the US in particular that the reminbi was undervalued against the dollar by as much as 40 per cent. This gave the Chinese a massive competitive advantage, leading to huge imbalances in the pattern of trade between China and America. This decision will not guarantee that imbalances will be eliminated, but removes a source of great friction between the world’s two main powers. The immediate impact, as the Chinese currency rise, is to give Chinese people greater purchasing power over foreign assets, such as commercial and high quality residential property in the UK! Property Update
House Price Outlook Following a 21 per cent fall in values between October 2007 and February 2009, average house prices across the UK have now risen around 14 per cent in just over a year according to the Nationwide index. This strong recovery has been ‘mortgage-less’ – meaning that it “Average house prices has occurred despite tight lending conditions and low mortgage availability. The market has been characterised by low supply and high demand, giving rise to strong upward pressures across the UK have on prices. Those that have been able to buy are generally more equity- and cash-rich than the now risen around 14 average buyer has historically been. Signs of a greater balance between supply and demand are returning. Agents have been per cent in just over reporting a strong increase in new instructions whilst viewings remain where they were a year a year” ago. Sellers are clearly starting to take advantage of recent price rises, seeing this as a good opportunity to sell into a rising market. However, those equity- and cash-rich buyers who have supported prices up to now are gradually leaving the market as they make purchases. The mortgage constraint will start to bite again. Against this backdrop, we have taken a conservative view on the outlook for house prices. Our forecasts suggest that the 2010 average house price will close just 1 per cent up on 2009 prices. We expect that growth will resume to near historic average levels by 2011 at 7 per cent and at 8 per cent in 2012. Given that house prices are currently 3.5 per cent up on the end of 2009, a 1 per cent forecast for 2010 as a whole suggests that the second half of 2010 will see some falls in values. We expect this to a be a consequence of a number of factors – uncertainty in the wake of the election outcome, an increase in supply, a fall in the number of equity-rich buyers, and mortgage constraints starting to bite.
Figure 1: National average house price forecast (Source: Nationwide and Volterra Consulting) Property Update cont.
Commercial Property Overview Capital values have been growing strongly since August 2009 across all commercial property sectors, meaning that initial yields at the all property level have moved in from 7.9 per cent to “Retail property 6.7 per cent according to the IPD. values have posted Retail property values have posted the strongest growth, increasing 16 per cent since the the strongest growth, bottom of the market. Of ce properties have posted 11 per cent growth and industrial properties have seen 10 per cent growth. increasing 16 per cent As gure 2 makes clear, the pace of monthly growth in capital values amongst commercial since the bottom of property is down from the incredible highs we saw right at the end of 2009. However, even the 1-1.8 per cent growth we are currently witnessing compares favourably with the 0.7 the market” average attained over the 2002-mid 2007 long boom. It may well be good news that some of the heat has come out of the market. The level of growth immediately coming out of the crash would not have been sustainable over the longer term, and a return to reasonable levels of growth is better for market stability.
Figure 2: Month on month growth in capital values (Source: IPD)
Property Update cont.
Since the onset of rental value declines in April 2008, of ce rents have fallen furthest with a 17 per cent decline. Retail rents have so far fallen 8 per cent and industrial rents 6 per cent. At the headline level rental value growth looks set to turn positive within the coming months. Average of ce rents are already growing, albeit at an extremely marginal 0.1 per cent in the latest month’s data. However, headline rents hide signi cant increases in rent frees during the recession. Whilst headline rental falls have not been overly dramatic, increases in rent free periods were signi cant in some sectors. 36 months rent free in a 10 year lease is now not unusual in certain sectors. Landlords have shown a strong desire to maintain headline rental levels at the expense of signi cant rent frees. This is a long term play by landlords, who rightly believe that maintaining headline rents will be bene cial when it comes to renegotiating leases. The London market however tells a slightly different story. In retail rents are beginning to “Headline rental stabilise and incentives are falling slightly. West End of ces too have seen rent free periods falls have not been shorten although it is now rare to have a 10 year lease. It is becoming far more common to have a lease break after year 5. For Business Parks the norm is rent free period of 12 to 18 overly dramatic, months, though this will vary depending on lease length and the individual circumstances. increases in rent free periods were signi cant in some sectors”
Figure 3: Rental values per square foot (Source: IPD)
Property Update cont.
So where do we see the commercial market going from here? There is a general feeling that the investment market is pausing for breath after the exuberance of the past 6 months. It was always known that the rate of growth witnessed over the past 6 months could not be sustained. The question is whether the market will now grow at sub 1 per cent per month levels, or whether it will actually turn negative. The amount of loans which need to be re nanced this year may bear on capital values –it is unclear whether banks will be willing to re-extend nance. If not, we will see forced sales and price falls. Although this is a possible outcome Volterra Consulting does not think it is likely in the current climate. Demand/supply is going to be central - the lack of new space being built will limit supply. The prospects of gilt yields stabilising or even falling thanks to the de cit reduction measures in the Budget means there is further room for commercial property price.
Figure 4: The yield gap
CONTACT: ISOBEL MCINTOSH 135C SHEEN LANE LONDON SW14 8AE TEL: +44 (0)20 8878 6333 www.volterra.co.uk
CONTACT: ANDY MARTIN HEAD OFFICE 13 HILL STREET LONDON W1J 5LQ TEL: +44 (0)20 7629 7282 FAX: +44 (0)20 7629 0387 www.struttandparker.com
N.B. Whilst every attempt has been made to ensure the accuracy of the content of this bulletin Strutt & Parker accept no liability for any damage or loss sustained as a result of its content.
Flickr Creative Commons Photography by: Katie@!’s, eyeliam, MagdaMontemor, law_keven, jovike, _b, ultrahi, wwarby, jock303, vgm8383, paul evans-rg&b, night86mare