2020 – The end of the paralysis
As we move to the next stage of Brexit, the UK is finally enjoying a sprinkling of confidence and a sense of purpose is emerging as it starts to focus on the domestic agenda and explore wider relationships. However, many things have not changed and prospects for 2020 should be considered within the context of:
- Ongoing battles with EU over trade agreements
- A world of increasing nationalism and protectionism
- A slowing world economy - with a near record number of trade disputes between countries likely to have a profound impact on global trade
- A rebalancing of the UK economy towards the northern England regions – especially major cities such as Manchester, Leeds, Birmingham and Liverpool
- The prospect of interest rates normalising over the next few years: most economists predict very little, if any, growth in the economy and unchanged interest rates in 2020, with gilt yields and swap rates trading within similar spreads to 2019
- An ongoing re-evaluation of location and sustainability through improving infrastructure, e-commerce, technological and demographic change
- Planning and dealing with obsolescence and environmental challenges, particularly structural changes across the retail sector and growth of “smart” buildings.
The outlook for 2020
- Growing business confidence, tempered by the ultimate timing for securing a trade agreement with the EU and possible repatriation of some EU functions in the UK
- Appreciation that the UK is likely to be economically and politically stable for the next five, probably ten years
- Average commercial property values will be flat, with fewer opportunities for organic rental growth – however, the retail sector is likely to decline further in the range of 5% to 10% according to IPF consensus forecasts (November 2019), which may prove to be conservative
- Opportunities for repositioning assets will gradually emerge as a result of obsolescence
- Continuing strong demand for property investments with long-term inflation-proofed income streams especially in alternative commercial sectors, together with industrial and beds (cradle to grave including student, care, retirement and assisted living)
- The Central London residential market, driven by equity investors, will probably begin to emerge from the doldrums and perform stronger than the broader domestic market across Greater London - where affordability remains stretched.
Comparative property performance
A predicted 2% fall in the value of institutionally held UK commercial property investments (2018: rise of 2%), resulting in total returns at around 4% (2018: 6%), will mask extremes between property sectors.
A revaluation lag is now catching up on retail assets (which form over 40% of some institutional portfolios), with shopping centre values probably recorded at around 20% fall over the year potentially enabling discounted sales to occur.
The relatively high sustainable income derived from the property sector, which has driven 75% of performance - average income return has been 5.5% over the past 15 years (source: MSCI Q2 2019), provides enduring value set against equities and gilts:
- The FTSE All-Share index currently provides an average dividend of 4.1%, with rise in value in 2019 of 14% and decline of 13% in 2018. Perhaps a positive sentiment towards UK domestic stocks might push the index higher by the end of 2020
- 10-year UK Government gilts have been trading at yields of between 1.30% and 0.37% over 2019, finishing at 0.86%.
Whilst financial market forecasters predict interest rates and gilt yields will gradually edge upwards. Our opinion is that we will witness a similar spread in pricing through 2020.
Currently available data from Nationwide suggests that UK house prices rose by 1.4% in 2019, with London falling around 1.8% and regional markets seeing growth up to 3%. Available forecasts suggest overall similar results for 2020, with stronger performance across the board from 2021.
Enhanced infrastructure in the regions
The Boris Government’s ambition to keep the “lend you my vote” electorate on side will result in a sustained focus on using infrastructure investment (HS2 as well as other rail projects are likely to proceed) and the NHS as catalysts. This should create opportunities for the development and construction community, where capacity may become an issue.
The NHS is about construction, estate upgrading and optimisation (both acquisitions & disposals) – whilst the solutions are complex, opportunities for the property sector are very promising.
Delivery of the government’s unfolding vision will however go beyond the next decade and rely on profound structural changes within the civil service, which has yet to begin.
Strong themes & income retention is key
There is a clear consensus that only those property funds offering specialist investment themes will attract inward equity flows in 2020 - be they long-dated index linked funds or sector specific.
This “climate of change” is moving away from generalist funds, especially with a high proportion of retail and other assets most affected by obsolescence and maintenance costs. Nevertheless, specialist and opportunist asset managers will seek out value in retail sub-markets where there is potential for re-positioning.
Publicly listed REITs are likely to recycle assets to remain in vogue although, unlike unit trusts, they are not forced to sell assets in times of equity outflows and should provide a good indirect entry to the market if share prices dip.
London vs. regional offices – differing fundamentals
Irrespective of which Brexit deal we finally end up with, London will continue to be a leading global financial centre and continue to attract foreign investment - due to slightly higher property yields, relative to comparative cities across Europe.
However, central London office markets, especially the City, face challenges ahead. Whilst some commentators report a shortage of Grade A space, with prospects for modest rental growth, the sub 50,000 sq ft market is subject to increasing tenant incentives and choice –24-months’ rent free for a ten year term, equivalent to a 20% net effective reduction, is regularly offered.
Whilst London’s working population is set to grow, an increase in agile working will negate the overall need for additional office space, with flexible leases shaking up the traditional market models and rendering historic data patterns obsolete.
Many regional office markets have a well-balanced supply and demand equation, with an outlook of relatively stable rentals levels.
The growth of the knowledge sector, adoption of a north-shoring strategy by London’s professional services firms and the media industry (the latest being Channel 4‘s impending move to Leeds), a drive to reduce costs by opting for cheaper accommodation and attracting/retaining talent by offering a better lifestyle will continue to be compelling drivers within the regions.
Regional cities should also benefit from the government’s strategy to locate new government agencies outside London, as part of an effort to “level up” opportunity and spread wealth across the country.
Flexible offices to battle on
The serviced office sector will continue to grow despite WeWork’s issues. We will surely see more M&A activity as the market becomes more crowded and there is a flight to quality and reduction in accommodation costs.
The flexible office sector already accounts for nearly 7% of the London office market and with estimates of it reaching 25% - 30%, the scope for ongoing market disruption will be on the forefront of all major landlords. Regional office markets will ultimately play catch-up: flexible office space is estimated to be approximately 3.8% in Manchester and 2% in Leeds. This will surely increase as a proportion of London operators look to the regions for growth.
Increasingly, the focus will be on place-making and the core needs of business, focusing on travel hubs, activated environments which integrate live/work, retail and food & beverage offers to serve employees and residents.
Retail – structural change brings winning locations & players
Despite the explosion of online retailing, the end of the high street is exaggerated – physical store networks will play a critical role in enabling online offerings.
However, the number of high street retail outlets and retailers continue to shrink, with certain sectors such as games, books, technology and some fashion specialists reduced significantly.
Whilst convenience, upmarket and experiential retailing will remain drivers, the main theme in the high street is re-purposing with the creative introduction of new diverse uses such as leisure, residential, community and workshop. A number of dated or dysfunctional shopping centres/ department stores have been sold for this purpose at quite strong prices, e.g. Nicholsons Shopping Centre in Maidenhead, Kennet Shopping Centre in Newbury and Debenhams in Romford.
Retail warehousing, benefitting from easy access, free parking and a natural click & collect point should have a stronger ongoing relevance, especially as they should attract ongoing strong occupational demand from value-focused retailers (think Aldi, Lidl, Iceland, Home Bargains, B&M and The Range) and leisure operators especially with F&B offerings, albeit off reduced rental levels.
The gradual switch to hybrid and pure electric vehicles will help consolidate retail warehousing and fuel stations which incorporate fast food/convenience units, with an increasing supply of fast charging points.
Pivoting away from distribution towards urban logistics
From being a standout investment performer in 2017-18, rental growth is now muted for distribution warehousing, at a time of very low yields. 2020 could see an inflection point for yields - smaller units in urban areas, either serving last mile deliveries, or other businesses should remain in a structural supply-demand imbalance, with ongoing growth prospects. So should self-storage, which provides a low overhead solution for start-up online retailers.
Digital technology comes of age in 2020
Apart from the use of blockchain technologies and the rise in analytical tools, landlords and tenants alike will become increasingly aware of how they can leverage data in their business.
Beyond 2020, there will be a massive growth in ‘big data’, streamlining the operation of “smart” buildings and, the use of Building Information Management Modelling (BIM) will be a major feature of the construction and refurbishment sectors.
Immediate considerations include:
- The future-proofing of buildings ... from operational to security to ‘green management’, ultimately with a push towards net carbon developments
- The Digital Occupier/Tenant Experience, which will become more critical to our management of assets – everything from data control and protection (think cyber security), to enhancing the speed and quality of the interaction between landlord and tenants, to enhancing the occupier’s ‘living-with the building’ (be it resi or commercial) experience
Integration & sustainability
2020 will be the year when owners and occupiers alike introduce policies on integration and sustainability into their investment risk assessments – buildings account for one third of energy consumption and 40% of all C02 emissions.
The plans by HM Treasury to rewrite its rules for assessing value for money, which will permit investment based on wider wellbeing of people in certain areas, rather than direct financial benefit, should boost property development in areas such as senior housing, supported living, community facilities, healthcare and education.
2020 is set to be another year of extremes for property, with local knowledge and asset management key ingredients to provide guidance in a changing market.
Assuming the UK secures a trade deal by December 2020, even if it is interpreted as a hard Brexit, business confidence, which will surely ebb and flow up to this point should strengthen together with inward investment - given the UK’s renewed sense of political stability.
The Conservative Government’s 80 strong parliamentary majority should enable the regional strategy to be closely linked to ‘votes retention’ and a 10-year infrastructure and NHS plan – led by a national strategy which this government (and Dominic Cummings) are pursuing.
The pace of rebalancing the UK economy will pick up, with the longer-term trend of London’s economic performance no-longer out-performing the regions. The outflow of London’s population from the professional classes, will be balanced by an increasingly younger international mix and the City will retain its No1 mantel for financial services, with London continuing to be a favoured destination for overseas investment.