UK commercial property market off to positive start in first-quarter
This point in the calendar can be a difficult time to read the market. Annual predictions are made in December, but it is April before much of the hard data can begin to indicate their validity.
3 minutes to read
Divides of March
Our view is that the year has got off to a positive start: MSCI’s latest monthly data shows all-property returns still matching December’s pace (11.2%), the IPF’s consensus forecast for 2018 returns have edged up to 4.6% (closer to our prediction of 7.0%), and at almost £10bn, investment remains healthy.
"February’s equity market volatility was a helpful reminder of real estate’s comparative stability and attractive income-generating abilities."
However, headline numbers are good at masking more nuanced trends, and what seems clear to us is that divisions within the UK’s commercial property market are widening on a number of fronts.
The stable performance reported in MSCI’s data reflects (still) improving returns in industrial and specialist property types, weighed down by an accelerating decline in values amongst certain retail subsectors.
Our in-house yield series mirrors this trend: few changes have been necessary this year, but we have raised our prime regional high street yield, and lowered those for some of the specialist property sectors. Equally, while investment is tracking last year’s levels, activity is concentrated within the office, industrial and specialist sectors.
There are also growing divisions in the global macro background that could have important implications for real estate. February’s equity market volatility was a helpful reminder of real estate’s comparative stability and attractive income-generating abilities.
Indeed, overseas capital remains focused on UK real estate, as evidenced by the number of large portfolio and single asset purchases that have already taken place this year, and we continue to expect 2018 to be a strong year for entity-level transactions.
However, the cause of recent stock market fluctuations was alarm at the speed of monetary tightening in the US, and consequently, 2018 will see much debate as to the impact of higher interest rates on property performance, and financial markets in general.
Et tu, Mark Carney? No.
The reality is that the paths of global interest rates are diverging. Despite a slightly more hawkish tone of late, the Bank of England is set to tighten nowhere near as quickly as in the US Federal Reserve, which has already increased its target interest rate to 1.75% and may reach 2.5% by the end of the year.
The importance of this differential to those in the UK (and Eurozone) is partly that the US experience offers a useful glimpse at the impact of rising interest rates on property pricing.
So what has happened? Have higher US interest rates caused property yields to rise in lockstep, thus leading to property value falls?
"Despite a slightly more hawkish tone of late, the Bank of England is set to tighten nowhere near as quickly as in the US Federal Reserve, which has already increased its target interest rate to 1.75% and may reach 2.5% by the end of the year. "
Or has the yawning gap between property yields and government bonds simply compressed to a lower number of basis points? The answer, for now, is the latter: in general, US property yields have been in decline ever since the central bank started raising rates. This is a reassuring illustration of our view that rising interest rates, of themselves, need not lead directly to lower property values.
End of Act I
As the first quarter draws to a close we can reflect on some of our own predictions from the start of the year: we were right to expect greater stock market volatility (although we didn’t anticipate the trigger to come quite so soon), while appetite for platform and corporate transactions has been even stronger than we thought.
Our central case for 2018 remains one of benign moderation in performance, and consistent demand for assets.
For more information on any of the points discussed in this article, please contact Anthony Duggan or William Matthews