INVESTMENT BRIEF The definitive guide to UK commercial property investment Winter 2020 geraldeve.com CONTENTS Executive Summary 3 Economic Overview 5 Industrial 8 Offices 10 Retail 12 Hotels 15 Leisure 16 Corporate Finance 18 Gerald Eve in the Market 20 Further Insight 22 Contacts 23 2 INVESTMENT BRIEF EXECUTIVE SUMMARY Quarterly UK property investment by segment Sources: Property Data, Gerald Eve £ billion 20 18 16 14 12 10 8 6 4 2 0 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 Q3 2018 Q4 2018 Q1 2019 Q2 2019 Q3 2019 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Office Industrial Retail Leisure Alterntives The pace of the initial economic recovery in early summer This mixed picture was also reflected in yield movement in Q3. was strong after the initial lockdown measures were relaxed Retail yields moved out further and capital values continued to and GDP rose by 15.5% in Q3. But this figure masks a loss of tumble, notably for shopping centres. Office yields edged up momentum from August, and in September output was still but were broadly flat overall in Q3, after a shift out in Q2. But more than 8% below its pre-pandemic level. Business survey competition over industrial assets meant that yields actually data pointed to a further loss of momentum in October as local sharpened in Q3, and higher frequency data show that capital Covid-related restrictions became more stringent. growth intensified into the first month of Q4. The second lockdown in England in November (with similar We expect All Property rents to fall 2.9% in 2020, and a further restrictions in other parts of the UK) and ongoing stricter tiering 0.7% in 2021 – driven by the tail end of the retail repricing and from December means that UK GDP is set to fall by nearly 3% in offset by more positive growth in industrial. Following similar Q4 and the 2020 GDP forecast has been revised down to -11.3% sector dynamics there will be a 30bp outward yield shift in 2020 (from -10.3%), before a recovery of +5.2% in 2021 (from +6.7%). but we expect more investment stabilisation in 2021 industrial finishes its miniboom and retail losses are fully priced in. UK commercial property investment staged a small recovery This would generate total returns of -4.5% in 2020 (the first in Q3 to £8.1bn, up from £4.3bn in Q2. The figures for the first negative annual return since 2008) and +6.0% in 2021. three quarters of 2020 have been significantly bolstered by the Alternatives sector (notably Blackstone’s £4.4bn acquisition of the IQ Student Portfolio in Q1), without which just over £20bn was transacted – the most subdued since the financial crisis. There are disparities across property sectors, with retail and leisure investment volumes at record lows while the much more buoyant industrial segment notched up nearly £2bn in Q3 with a return of portfolio deals. EXECUTIVE SUMMARY 3 The investment market for industrial is currently active and liquid. Unlike other real estate segments, confidence in the All property total return and components underlying occupier market is high. Voids continue to be low Sources: MSCI, Gerald Eve and further rental growth is anticipated, especially in the South East. The investor buyer pool for multi-let widened in %, per year Q3 and portfolio deals made a significant return. With rents at 30 all-time highs, capital values are back to their peak or beyond. Weakness in H1 will have caused a dip in the 2020 annual total 20 return to +4.2% (the lowest since 2012), but industrial will easily FORECAST outperform the other property segments. H2 positive rental 10 growth and yield compression – particularly in London & the 0 South East – is likely to be sustained into 2021 and drive an improved 7.9% annual total return. -10 -20 -30 2017 2013 2012 2019 2015 2016 2018 2014 2010 2011 2021 2022 2007 2020 2009 2005 2006 Following record low activity in Q2, office investment increased 2008 by 54% to £2.3bn in Q3. Many of these were transactions that Income return Yield impact were under offer pre-covid. The buyer pool has shrunk, and – Rental growth Total return unlike Industrial – the extra due diligence process has increased the typical transaction time. This will help some investors be more selective in acquisitions, while others will put the onus on guaranteed income over building quality. High quality London offices with strong covenants are garnering the highest level of Whilst the retail sector is undergoing a structural interest, notably from overseas buyers. Meanwhile demand for re-pricing accelerated by Covid there are others, value-add stock across the UK has become increasingly careful and tentative. Our outlook for offices has improved, following such as consumer-focused logistics and real estate lower than anticipated falls in rental growth this year. However, supporting the digital world, that have actually forecast annual total return will be negative, at -4.8% for 2020. benefitted from the pandemic. The market dislocation that we are witnessing will bring with it investment opportunities, and in a world of subdued returns those assets that best capitalise on these broad megatrends have the greatest alpha potential. Retail investment increased in Q3, but remains severely depressed, especially for shopping centres. The small tick John Rodgers up was driven by increased investment activity in the Partner less distressed sub-segments – namely retail warehouses, Tel. +44 (0)203 486 3467 supermarkets and some portfolio deals. Retail rental growth fell [email protected] into deeper negative territory in Q3, while anecdotal evidence suggests that late and non-payment of rents continues. The outlook is poor, with store closures at the start of the critical Christmas trading period, the worsening economic backdrop and as shoppers shift increasingly online. Total return is forecast to be -17.8% in 2020 but will compare favourably with the other property segments again by 2022 with investment market stabilisation and a relatively high income return. 4 INVESTMENT BRIEF ECONOMIC OVERVIEW The impact of the second lockdown in England in November (with similar restrictions in other £ parts of the UK) will be less severe than the first. Nevertheless, Oxford Economics expects GDP to fall by nearly 3% in Q4 and the 2020 GDP forecast has been revised down to -11.3% (from -10.3%), before a recovery of +5.2% in 2021 (from +6.7%). The pace of the initial recovery in early summer was strong after the initial lockdown measures were relaxed and GDP rose by 15.5% in Q3. But this figure masks a loss of momentum from August, despite support from the ‘Eat Out to Help Out’ scheme and the reopening of schools. In September, output was still more than 8% below its pre-pandemic level, with much of the services sector reporting significantly larger gaps. Business survey data pointed to a further loss of momentum in October as local Covid-related restrictions became more stringent. Manufacturing sentiment and output is likely to plunge in November. But given that the sector has not been forced to close, the drop in output is likely to be smaller than the fall in wider GDP and the overall fall in 2020 is set to be lower than for consumer spending. The Job Retention Scheme (furlough) has been extended to the end of March 2021, which will ease upward pressure on unemployment. However, participating in the scheme will cost employers more than it did in the first wave through national insurance and pension contributions. Ultimately, when this fiscal support is withdrawn, unemployment is forecast to peak at around 7% in Q2 2021 on the ILO measure. Recent news of effective potential vaccines should provide a significant boost in the fight against coronavirus, but the complexities of implementing a comprehensive inoculation programme suggests that any economic benefits are unlikely before H2 2021. The other key factors influencing the UK outlook are: sustained monetary policy support through further quantitative easing over 2021 and mooted negative interest rates that will keep bond yields below 1% through to 2023; very low inflation, which reflects the temporary VAT cut for the hospitality sector and generally weak domestic economic activity – this will provide a boost to household spending power; and extra trade frictions due to Brexit from customs bureaucracy and some regulatory barriers that will weigh on export competitiveness. ECONOMIC OVERVIEW 5 Monthly UK GDP Key macroeconomic variables: history and forecast Sources: Oxford Economics, Haver Analytics Source: Oxford Economics February 2020 = 100 2015 2016 2017 2018 2019 2020 2021 2022 105 GDP growth 2.4% 1.7% 1.7% 1.3% 1.3% -11.3% 5.2% 6.4% 100 Consumer spending 3.0% 3.7% 1.0% 1.3% 0.8% -14.8% 5.2% 8.3% 95 growth Manufacturing 90 -0.5% 0.3% 2.3% 1.1% -1.7% -12.0% 2.7% 2.8% output growth FORECAST 85 Services 1.8% 1.7% 0.6% 0.7% 2.1% -1.2% -2.7% 3.4% employment growth 80 10-year bond yield 2.0% 1.3% 1.3% 1.3% 0.9% 0.4% 0.3% 0.7% 75 RPI inflation 1.0% 1.7% 3.6% 3.3% 2.6% 1.5% 1.7% 2.5% 70 Jan’20 Apr’20 Jul’20 Oct’20 Jan’21 Apr’21 Jul’21 Oct’21 6 INVESTMENT BRIEF INDUSTRIAL for over £400m. There were also some significant multi-let deals • After a dip in Q2, the investor pool widened in in the regions in Q3, which includes L&G’s £60m purchase of Q3 and the market is active, liquid and efficient - Hillthorn Park in the North East.