UK commercial property overview and outlook
The main upfront economic interruption from the country-wide coronavirus lockdown has been quantified and UK output is estimated to have fallen by 20.4% in Q2. The UK is officially in recession – the deepest one in the G7. Despite a 2021 bounceback there will be some significant sustained output losses and the economy will not return to its pre-pandemic level of output until 2022. The manufacturing sector is set to be hit much harder and take many years longer to recover.
Q2 also marks a low point for commercial property investment transactions, with the total down 70% quarter-on-quarter to just over £4 billion. Investors were risk-off in Q2 and trading centred on operational assets such as logistics, supermarkets and residential build-to-rent. The high residual land values of London assets also attracted interest and SEGRO’s £203 million purchase of Perivale Park in London was the largest deal of Q2.
A fall in the equity dividend yield in line with the summer stock market recovery has meant that the commercial property sector looks increasingly expensive to income investors. However, as bond yields have fallen to new lows, and the spreads with property are relatively high, there is still a helpful risk premium cushion for commercial property over the medium term.
Property yields moved out sharply at the end of Q2, notably for Retail and Leisure, where business operations have been hardest and most directly hit by the lockdown. For 2020 as a whole we expect rents to fall 3.2% and yields to soften by 60 basis points – driven very much by the beleaguered retail sector. Higher yields will weigh on capital values and we forecast a 12% fall in capital values and a total return of -9%, the first negative annual return since 2009, before stabilising in 2021 without a significant bounceback.
If the growth of e-commerce has been the defining economic trend of the past decade, it is industrial property, and multi-let in particular, that has been the biggest beneficiary of this shift. Stronger fundamentals have driven increased investor appetite, and this in turn has driven yields to record lows. The flipside, of course, has been the flight from retail space, and the opposite directions of travel for capital values in the respective sectors has seen the traditional hierarchy reversed.
Nick Ogden, Partner, Capital Markets
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