UK Real Estate market commentary - Q4 2019

The election of a Conservative government with a large majority means that the UK will leave the EU at the end of January.  There will then be a transition period which will maintain existing arrangements while a new trade deal is negotiated.  Our central scenario is that there will be a deal, because it is in both sides’ interests.  However, if the UK government insists that the transition period stops at the end of this year, then there may only be time for a deal on agriculture and goods and not services.  Schroders expects that the UK economy will grow by 1% in 2020 and that the Bank of England will leave interest rates on hold until a trade deal is agreed.  Next year could see an acceleration in growth to 2%, assuming there is a trade deal and investment recovers and the government raises spending.  The Bank would probably increase base rate to 1.5% by the end of 2021.

At the national level, office employment increased by 2% p.a. in 2019, driven by growth in tech, media and professional services.  However, the overall picture masks a long-term shift in demand to offices in city centres and away from smaller towns and suburban office parks.  In part this reflects employers gravitating to where there are large pools of skilled staff, but in part it is also due to technology (e.g. chatbots, robotic process automation) cutting mid-skilled jobs in back office administration and call centres.  We expect office rents to be broadly stable in 2020 and to rise from 2021 onwards, as the economy strengthens.  The West End will probably lead the upswing in London, followed by Bloomsbury, Farringdon and Whitechapel which should benefit from Crossrail when it finally opens.  Outside London we expect that the strongest office rental growth will be in cities with strong universities and critical mass in tech, media and professional services (e.g. Bristol, Leeds, Manchester).  These cities should also gain over the long-term from the devolution of public services and higher spending on infrastructure.

We expect industrial rents to follow a similar trajectory, pausing in 2020, before rising in 2021.  While there is an underlying shortage of industrial estates, we expect that manufacturers who account for a third of the space on estates will hesitate to sign leases until there is a trade deal with the EU.  Demand should pick up in 2021 assuming a deal is agreed and rental growth should resume.  By contrast, rents on big distribution warehouses are more likely to be held back in the short-term by supply than demand.  Although they will continue to benefit from the growth in on-line retail (manufacturers account for less than a fifth of space), the last two years have seen an upturn in speculative development of big warehouses, particularly in the Midlands.  As a result vacancy has risen and this, coupled with the downward pressure on logistics firms’ profit margins, means that distribution warehouses rents will be static through 2020-2021.

The retail sector is tough.  The first quarter of this year is likely to see more retailer insolvencies and it is now routine for retailers to ask for cuts in rent, either at lease expiry, or in exchange for lease extensions.  We expect that on average retail rents will fall by a further 12-15% over the next three years, as on-line penetration increases and as discount retailers take market share from mid-market brands.  The most defensive types, in relative terms, are likely to be convenience supermarkets by transport hubs and bulky goods retail parks.  Rents on bulky goods retail parks are generally affordable at 6-8% of sales and there is still demand from retailers who need showrooms to display goods and give expert advice, discounters and gyms.  Bulky goods parks and convenience supermarkets also suit click and collect sales.

The total value of investment transactions fell by a quarter between 2019 and 2018.  Investors adopted a wait and see approach to the general election and Brexit and liquidity in the retail sector dropped sharply, as the insecurity of income made it difficult to agree prices.  The open-ended M&G Property Portfolio was suspended in December, although so far it has been an isolated event.  We expect the all property initial yield to rise from 4.7% to 4.8% by the end of 2020, but the increase will largely be driven by retail.  By contrast, yields on London offices are likely to fall this year despite the uncertainty over a trade deal, because after three years on hold, they are now unusually high compared with office yields in Berlin, Paris, Hong Kong and Tokyo.  Regional office and industrial yields will probably be flat in 2020.  

We forecast that all property total returns will be around 2% in 2020, before improving to 5-6% p.a. in 2021-2022, as the economy accelerates and rental growth resumes in the office and industrial sectors.  Our main focus for diversified portfolios is on offices in certain London sub-markets and winning cities such as Bristol, Leeds and Manchester and on standard industrials outside London.  We also favour some niche types (e.g. hotels with management agreements, retirement villages, social supported housing) which are benefitting from long-term structural forces and offer attractive returns.  We are cautious of retail, but may invest opportunistically in bulky goods retail parks where rents have re-based to sustainable levels, or where there is the potential for higher value alternative uses. 


Important Information. 

For Professional Investors only.

The views and opinions contained herein are those of Schroder Real Estate Investment Management Limited and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This information is a marketing communication. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy.  Information herein is believed to be reliable but we do not warrant its completeness or accuracy. Any data has been sourced by us and is provided without any warranties of any kind.  It should be independently verified before further publication or use.  Third party data is owned or licenced by the data provider and may not be reproduced, extracted or used for any other purpose without the data provider’s consent.  Neither we, nor the data provider, will have any liability in connection with the third party data. The material is not intended to provide, and should not be relied on for accounting, legal or tax advice.  Reliance should not be placed on any views or information in the material when taking individual investment and/or strategic decisions.  No responsibility can be accepted for error of fact or opinion. Any references to securities, sectors, regions and/or countries are for illustrative purposes only. 

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.  Exchange rate changes may cause the value of any overseas investments to rise or fall. Past Performance is not a guide to future performance and may not be repeated. 

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. UP000048.

Contributes to
Unstructured Learning Time

CPD Accredited