In this latest edition of The House View, we explore post-Covid work styles, a return to normality in residential property markets, how the retail industry is recovering from the pandemic and much more.
There will be more Covid-19 variants and inflation fears, but the direction of recovery is set and interest rates won’t rise yet, while greenwashing concerns prompt sustainable investing probes and the search for evidence
Economic growth is slowing in major economies due to the continued spread of the Delta variant of Covid-19, and supply chain issues. Other new variants, such as that in South Africa, could be even more concerning. But if vaccines remain effective, we believe that the economic growth trajectory is set and the IMF’s forecast of 6% could be reached.
Economies are troubled by shortages of parts, materials and labour, and slow and expensive shipping, prompting inflation fears. We believe any spike is likely to remain transitory and that central banks will not be pressed to raise rates soon. Even in the event of rate rises, property investors are unlikely to get spooked.
After the annual Jackson Hole meeting of central bankers, at the end of August, the Federal Reserve reiterated that tapering could begin later in the year, setting the stage for rate hikes in early 2023. Investors may look to capitalise on the record low cost of borrowing underpinning demand in markets.
ESG credentials will continue to drive regulation and investment, but now with greater urgency given the stark warnings by the UN’s IPCC. However, as we pointed to last year, there is little clarity in how to measure these endeavours and there will be greater scrutiny – our latest research looks to start filling this gap. America’s Securities and Exchange Commission (SEC) has said it wants to crack down on “greenwashing” and the issue has been highlighted recently in articles by Tariq Fancy, former chief investment officer for sustainable investing at BlackRock, and The Economist to name a few.
Housing markets have more room to run, but we are not in a bubble. Travel bans will impinge on cross-border transactions well into 2022
National and city-based house price indices are surging, yet this is a story largely confined to advanced economies where support measures have protected jobs and enabled significant savings. The scale of demand, driven by a reassessment of living conditions, looks set to continue based on the results of our recent Global Buyer Survey that found 64% of homeowners expect the value of their primary residence to increase in the next 12 months. Almost a fifth of respondents said they had moved house since the start of the pandemic and of those yet to move, 20% are considering relocating in the next 12 months.
Unlike in 2008, banks now operate under tighter lending rules, households are less indebted, there is not expected to be a sudden jump in unemployment or interest rates, and governments are taking a much more interventionist stance to deter speculative activity. But, perhaps most critical is the extent to which several key markets continue to suffer from a severe undersupply of housing.
The Delta variant along with a mixed vaccine rollout programme means it will be 2022 before we see any significant international travel. Uncertainty surrounding restrictions and the removal of the US from the EU’s ‘safelist’ at the end of August not only make it challenging to undertake viewings and agree sales overseas, but point to the stop/start nature that lies ahead for global buyers. As vaccine passports gain traction, countries with advanced vaccine programmes, like the US, UK, Canada and the UAE, will emerge as influential drivers of prime markets in the second half of 2021.
Global capital markets
Summer commercial real estate investment ramps up, real estate to benefit from M&A activity and price pressures will ease
Typically known as quiet months for investors, July and August have proved anything but in 2021. In the year to August-end, global investment was 11% higher than in the same period a year prior. With fewer than four months left in the year, we expect commercial investment volumes to comfortably outstrip 2020’s understandably muted year, supported by low borrowing costs and the continued reopening of overseas travel.
Like commercial real estate investors, businesses are making up for lost time when it comes to dealmaking. Global M&A activity is set to surpass 2007’s record year, thanks to the tech and real estate sectors that have contributed $832bn and $312bn, respectively, towards the $3.9tn 2021 total to date. We expect this surge in M&A activity to result in more commercial real estate being made available to the investment market; corporate real estate portfolios are often scrutinised – and sometimes rationalised – as part of new business and operational strategies.
Inflation remains a key concern for investors. Some fear that persistent price rises could lead to higher interest rates and a possible negative impact on asset values. In fact, real estate often acts as a useful inflation hedge. However, as we believe that price pressures will ease towards the end of the year, any enthusiasm central banks may have had for significant monetary tightening will be dampened.
Global office market
Twice bitten, thrice shy: the cautious return to the office is back on, the phoney office space war is over and the narrowing window of opportunity will lift activity levels
As summer ends in the northern hemisphere, ‘back to the office’ has joined the traditional refrain of ‘back to school’. Early evidence from transport and building usage data does suggest a response. Yet caution prevails given the staccato progress towards re-occupancy evident over the past 18 months. Ten of our 15 global gateway markets still report office occupancy below half of typical levels, whilst tech titans Google and Apple have delayed their return to the office until early 2022. Momentum is indeed building but there is still considerable road to run.
It is unlikely that the current road brings a return to pre-pandemic levels of occupancy. Our re-entry into the office will instead be more fluid and flexible, reflecting a real shift in working styles. More than one third of the 1,300 Global CEOs recently surveyed by KPMG has already implemented hybrid work styles, combining remote and office-based working. This not bad news for offices. Only one-fifth of those same CEOs are planning to reduce their physical footprint, compared with almost 70% who planned to do so a year ago. Many of the claims of drastic space reduction that appeared early in the pandemic now appear well wide of the mark.
The increasing pro-office tone among business leaders, and the window of opportunity presented by global office markets, will bring renewed momentum to market activity. More than 70% of the 90 markets covered in our Global Occupier Dashboard are presently occupier favourable, but many become more challenging – especially for those seeking premium quality offices – from 2022 onwards. We fully expect occupiers to move rapidly from analysis to action against this backdrop.
UK will be one of fastest growing, advanced economies this year. Brexit compounds supply chain issues and puts pressure on prices, but investors should hold their nerve as rates remain at record lows
The UK is forecast to be one of the fastest growing advanced economies with 7% growth in 2021, according to the IMF. With most Covid-19 restrictions being lifted on 19th July in England, the road to full recovery has become clearer. Supply chain issues and ongoing Delta disruption will continue throughout 2021 but the economy is continuing to open up and cities are rebounding. The week beginning 6th September saw London’s Tube passenger demand rebound to over 50% with smart building software company, Metrikus, noting that of the buildings they monitor, use increased to 82% of February 2020 levels.
Supply chain shortages are hitting the UK more acutely than other nations as it contends with disruption within and outside its borders from the pandemic exacerbated by Brexit. Shortages of labour could last another two years, according to the CBI, yet material prices are expected to fluctuate as bottlenecks loosen.
This equates to inflation rising in the coming months, The Bank of England is expecting it to peak around 4%, but then fall back in line to the 2% target. Investors should prepare for a greater level of inflation volatility than over the previous decade, but don’t be alarmed by current distortions.
The Bank of England’s stance towards inflation indicates no immediate withdrawal of monetary stimulus, we believe it will likely be 2023 before a rate rise. Lending rates are hitting new lows with the introduction of a five-year fixed mortgage from Halifax, for those with a 40% deposit, of below 1%. It appears mortgage rates may be bottoming out which will underpin activity in property markets.
Explosive market is beginning to calm, international buyers start to show interest and it’s now a landlord’s market, in a script you couldn’t write
The UK housing market in 2021 resembles a bad Hollywood blockbuster – an explosive start followed by a predictable finale. As the second act begins this autumn, the unfolding mystery surrounds supply. Will low interest rates, upbeat economic surveys and calmer conditions lead to more listings? Or will owners want an extended break until Christmas after the drama of successive stamp duty holiday countdowns?
The inevitable answer is a bit of both and we expect the market to become more needs-driven as the pace goes from frenetic to brisk. Demand is robust and UK price growth should narrow as supply picks up. Take your pick of what the final number will be but it’s likely to be in single digits.
Meanwhile, after the initial exuberance of a rural exodus, the mundane reality of amenities and transport infrastructure are back on buyers’ radars outside the capital. In London, prime markets could provide a late plot twist if international buyers return in meaningful numbers, after all, every good film needs a last-minute dash to the airport. Some locations are certainly now a comparative bargain.
How quickly will web traffic become air traffic and create upwards pressure on prices? The strictness of quarantine rules on the return leg may still deter some.
Blink and you may have missed it, but it is now a landlord’s market in prime London. International students are back and corporate tenants are looking for a London base as offices re-open. Supply is low in many areas for reasons explored here. Such is the ferocity of the competition, a number of tenancies have been agreed several hours after listing based on a single virtual viewing. We expect rents to end the year flat, something we never thought we’d say just two months ago.
UK residential investment
Investors will continue to back residential, applying downward pressure on yields
Demand for income-producing property showed little signs of cooling in the first half of 2021 as investors continue to shift their focus towards operational-type assets.
We’ve explored how the student, multifamily and seniors housing markets have been key beneficiaries of this trend – largely buoyed by their resilience against what has been an uncertain and changeable backdrop. Just shy of £5bn was committed in total across H1. Strong showings in the build-to-rent and seniors housing markets in particular mean we expect both will report record years in 2021.
We expect this combination of strong investor demand and positive sentiment around the performance of residential investments will combine to put downward pressure on yields, something we highlighted in our recent Q2 Yield Guide.
UK capital markets
Global investor appetite for UK real estate remains strong, commercial property outlook improves and a new record set for industrial investment
The UK remains the leading recipient of overseas capital for commercial real estate investment during 2021, comfortably ahead of Germany and the US, which rank second and third respectively. We believe that the rapid rebound in economic activity, ongoing vaccination success and clarity over Brexit impacts has renewed confidence amongst those previously hesitant about deploying capital.
The 2021 outlook for the UK commercial real estate market is more positive than anticipated three months ago with the Investment Property Fund’s consensus total return forecasts for the year improving from 4.4% to 6.9%. This means that, as an asset class, commercial real estate is now offering considerably higher expected returns than government bonds. We therefore expect the market to continue to attract capital from both domestic and overseas investors.
Among the various commercial real estate sectors in the UK, industrial property continues to see rising demand. In terms of investment, the sector has seen its highest second quarter on record. Total activity in 2021 so far has reached £10.4bn, a level already above the whole of 2020. In our view, favourable structural changes in consumer behaviour and strong occupier demand will continue to translate into healthy rental prospects. Consequently, while yields are already low in comparison to historic levels, we expect the sector to continue to attract interest from a broad range of capital sources.
Consumer bounce back will extend to the Christmas period and beyond, expect a Q4 flood of retail investment stock and beware of 2022 occupational ticking time bomb
Ignore everything the media has to say about retail sales in the coming months and over the all-important Christmas period. We forecast that retail sales will grow by around 5 to 6% year on year in Q4 2021. This will be significantly below the artificially elevated growth immediately post lockdown (Q2 +21.3%), but decelerating growth will still be good growth. The UK consumer is in good health and continues to spend freely.
Expect a sharp reversal of year to date transaction volumes, with many bank-led shopping centre sales coming forward towards the end of the year. A previously subdued market will quickly become swamped and we fear supply could overwhelm demand in some areas of the in-town market and pricing could be impacted. The window of opportunity of counter-cyclical buying opportunities could potentially slam shut before many investors even become aware of it existing.
The elephant in the room, trumpeting away in the long grass where the UK government has unceremoniously kicked it – rent arrears to the tune of £6.4bn accumulated during the pandemic. The moratorium on forfeiture has thus far prevented landlords from proactively taking action to recover monies owed, but this will be lifted in March 2022. Retailers need to work with landlords towards compromise solutions (for example staggered re-payments, lease re-gears) to avert a potential occupier blood bath. And put negotiations and contingency plans in motion now, rather than wait until March.
Added demand-side pressures, rising rents, and rising build costs will continue to cause construction delays
The fundamental market drivers remain unchanged from last year. E-commerce and home delivery demand continues to drive demand for space. However, the UK government is prioritising growth and investment in advanced manufacturing as a key component to its levelling-up agenda as well as the road to net zero. We expect manufacturing and alternative uses to become increasingly important in fuelling further growth in the occupier market.
We anticipate robust levels of rental growth. Demand for space continues, while supply-side constraints limit delivery of new stock. Occupiers are having to agree to longer lease lengths in order to secure space and rent-free incentives have decreased due to competition. Competition is particularly fierce for the largest units, with very limited options available.
Delays on building materials and inflated build costs will continue to impact development schedules over the next year. Expected completions dates are being pushed forward into next year, construction starts postponed or schemes put on hold. Delivery times for construction materials have increased sharply as supply chains struggle to keep pace with demand. Developers are having to reconsider their construction programmes to account for longer lead times for materials.
UK office market
Three consecutive quarters of rising take-up and a future under-supply of new buildings
Last quarter we saw enquiries and viewings bounce-back to pre-pandemic levels, but occupiers remain cautious about signing new leases, so the recovery in take-up continues to be a soft one and 40% below long-term average levels.
We expect this momentum to build into next year as occupiers revisit their space occupation requirements in what should be a strong economic climate. We’re already seeing this reflected in rising levels of active requirements in London which at 8.4m sq. ft is only marginally below the long-run average.
The breakdown of that demand demonstrates the much broader occupier base of London not being so dependent on the health of the financial sector. Where there is demand right now, it is directed towards the best-in-class buildings where rental levels achieved have been better than the market average. Accordingly, we’ve raised our average headline prime rents in the core City of London and West End markets back to pre-pandemic levels and have marginally improved our five year forecasts compared with last quarter.
There hasn’t been the same level of landlord or tenant distress in this downturn so the rise in availability has not been like previous cycles. There is some concern with the recent rise in tenant release space but at present the majority is contained in the City and Docklands, represented by a small number of lower quality buildings, and is less than one-third of overall availability.
The likelihood of the market being overwhelmed with too many vacant buildings is also reduced by a constrained development pipeline. Our analysis suggests this will fall short of typical levels of take-up for new and refurbished office space. This occurs at the same time as structural demand for these buildings rises. Occupiers are adjusting their office footprints in a post-pandemic world to meet with better employee wellness and sustainability requirements.
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