The Backdrop
A brighter outlook can be expected in 2021 with reduced uncertainty, albeit recovery will be gradual and unevenly spread.
Whilst expectations are being raised by the rollout of Covid vaccines, the UK-EU trade deal agreement and perception of Boris as a stronger leader, UK economic prospects will be driven by global politics and our relationship with the world - impacting all sectors of the property market.
As Brexit was predicated on the principle of greater international trade, the UK prospects will therefore depend on successfully navigating around China’s deployment of a ‘divide and conquer’ strategy, the prospect of a pro-EU Biden regime and renewed Russian aggression – witness the recent cyber-attacks on major US Departments.
The domestic agenda will continue to feature a strong ‘levelling up’ rhetoric, as the Red Wall Conservative MPs’ disquiet escalates. Promises of a Green Industrial Revolution will probably compete with existing commitments for conventional infrastructure spend. These ambitious targets will however mask the challenging social and economic extremes between the ‘haves’ and the ‘have nots’.
The true cost of the pandemic should start to reveal itself after Easter, coinciding with the end of the furlough scheme, unwinding of the stamp duty holiday and the anticipated rollout of Covid vaccinations. This should temper wide-spread exuberance, with structurally affected businesses - including traditional retail and office property sectors - cutting their asset values. Sectors and businesses not at risk of insolvency, default and a cash drain should prosper in H2 2021, following a strong increase in targeted investment spend. However, 2021 should be considered within the context of:
- An ongoing low interest rate and low inflation environment
- Rising unemployment
- Increased productivity – the result of better use of technology
- Growth in GDP – the UK economy is predicted to return to its pre-pandemic size by 2025
- A divisive ‘K’ shaped recovery, reflecting extremes within asset classes and across society
- Pockets of over exuberance with investment bubbles waiting to burst (Tesla share price up 800% in 2020)
- An ongoing revaluation of location and sustainability through improving infrastructure, e-commerce, technological and demographic change
- Active strategies to out-perform relative to low yield, buy and hold strategies
- The emerging agendas for climate change and ESG
The outlook for 2021
- A release of business confidence and consumer spending, however long delayed, ultimately resulting in a rapid rebound in GDP but filtering unevenly
- Geographic disparity will increase, as business spend becomes highly focused, necessitating government intervention
- Will some sectors, such as retail, continue to reshape - with extreme winners and losers
- Re-opening of international travel will be a driver for the prime end of the property markets, especially London, which will continue to attract overseas investors, although there will be a noticeable flight to quality and sustainability
- A decline in all-property capital values for commercial property because of structural headwinds, hiding modest rises for ‘in demand’ logistics, industrial, supermarket and healthcare assets, versus shopping center basket cases
- Average residential values to end the year will be steady, following an initial dip, due to the combination of the stamp duty holiday ending, rising unemployment and lower levels of demand. This compares to some commentators predicting annualized price falls of more than 5%, versus rises up to 6%
- Opportunities for repositioning assets will emerge as a result of structural, obsolescence and devastation to the hospitality and leisure sectors caused by Covid
- Investment transaction activity should improve, as forward-looking investors respond to the economic upturn in the second half of the year. Whereas past activity was driven by institutional and larger private equity players, looking ahead, the buyer universe will be a broader mix of domestic and international investors
- The Central London residential market, driven by equity investors, will probably begin to emerge from the doldrums, later in 2021
- Greater commuting distances: with WFH becoming part of a business and employee strategy, it will have knock-on effects on home space designs, provision of community and convenience facilities
Comparative property performance
A predicted 9% fall in the value of institutionally held UK commercial property investments (2019: fall of 2%), resulting in total returns at around minus 4.5% (2019: increase of 4%) based on the latest IPF Consensus Forecasts, will mask extremes between property sectors.
Positive returns for industrial and logistics assets contrast with a likely value fall for offices in the range of 6% - 10% and nearer 30% decline for shopping centres. Clearly, secondary and tertiary assets and those adversely affected by Covid will have seen significantly greater declines in value.
Nevertheless, relatively high sustainable income derived from the property sector in a normalized environment, at an average income return of over 5% continues to provide enduring value against equities and gilts:
The FTSE All-Share index currently provides an average dividend of 3.7%, down from 4.66% in June, with decline in value in 2020 of 12.5% and rise of 14.2% in 2019. 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 1.00% and 0.06% over 2019, finishing at 0.2%. Whilst financial market forecasters predict interest rates to remain low, they anticipate economic growth later in 2020 and an eventual increase in inflation towards a target of 2% pa – which may result in gilts rising during 2020.
Overall UK house prices rose 7.3% in 2020 according to Nationwide, with the East Midlands showing strongest growth of 8.6%. 2021 is however set to see overall declines in value after artificial levels of support fall away in the spring. Perhaps H2 2021 will show see a recovery.
Despite the 2020 hiatus, institutionally held commercial property remains the best performing asset class over a ten-year period, reflecting total returns of over 7% per annum versus equities at around 4% and Bonds at 4.5%. If the decade ahead brings ongoing low or lower interest rates, stabilized property assets should continue to be relatively attractive.
Strong themes & specialisation is key
A “climate of change” will continue to move away from generalist funds, especially with a high proportion of retail and other assets most affected by obsolescence and maintenance costs.
An over-riding theme will be regeneration and re-positioning, led by specialist and opportunist asset managers often in joint venture with traditional institutional investors, local authorities and government bodies. However, the quicker wins will be ground up development to meet the clear occupational demand from varying types of residential, under supplied industrial sub-markets and core services.
The pace of activity will also be reliant on debt finance becoming more readily available again, which could be some months down the line.
Future of the office
While the future of office has been much debated, what is certain is that there will not be one generic solution.
A post-pandemic return to the office will in part be driven by the directives from CEOs of large corporates (expect 3-4 days in the office), contrasting with more knowledge and IT based businesses better suited to remote working (2-3 days in the office), with scope to commute from further afield and enjoy a work/life balance enabled by more affordable accommodation.
Flexibility is emerging as a key ingredient for smaller businesses, but equally forward-thinking workspaces should be designed to facilitate the creation of communities of people with similar interests, skills and expertise whilst meeting their unique needs and values. These workplaces should be connected, collaborative, authentic, sustainable and experiential and above all, customised.
At least in the short term, the serviced office sector will benefit from companies looking to finesse their models and those adopting a core and spoke strategy which incorporates some WFH. Traditional landlords will ensure consolidation by moving more into the flexible working space (just as We Work ramps up its acquisition of freeholds) to create a more dynamic and increased provision of flexible workspace with an overall reduced required footprint - say 10% with ongoing degrees of physical distancing.
London to remain relevant post Brexit
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.
It is estimated that day-to-day desk usage rates before Covid were only circa 50-60% in both private and public sectors, therefore the scene was set for occupiers to rationalise, cutting both costs and ecological impact.
Whilst active demand has slumped and availability in London is up 50% on 2019, a large amount of pent up demand will go into 2021, resulting in a return to more normal levels of activity albeit occupation headcounts will be reduced by between 10-15% of pre-Covid levels. We anticipate that vacancy rates in London will peak in 2021, at circa 10%, but should fall in the second half by 2–3%, with annual take up 15% below long-term average.
We see a three-tier market is developing:
- Prime grade A
- Quality second-hand
- Lesser quality space
Demand will be more focused on well located Grade A buildings, which are still in short supply, however the emergence of grey space (being returned to the market by tenants) will under-cut other landlord offered space, dragging net effective rental levels down.
Retail – structural change brings winning locations & players
Despite the explosion of online retailing, the end of the high street continues to be exaggerated – physical store networks will play a critical role in enabling online offerings.
The retail market has become more polarised with Covid creating a dynamic which none of us could have predicted. However, the seismic change in the way people shop, with the increasing penetration of online shopping, has simply been accelerated by Covid. Following the wreckage in the high street and demise of department stores, the way forward will be repurposing and mixed-use redevelopments, involving residential, office and other service-led uses, increasingly in joint ventures between local authorities and developers.
Convenience stores, discounters and German food retailers should however continue to be dominant takers of space and shape the more positive prospects for retail parks.
If the government’s environmental agenda turns into reality, the gradual switch to pure electric vehicles will accelerate and 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
Despite low initial yields and arguably limited rental growth ahead for distribution warehousing where occupier demand is moderating, this sector will remain top of the investor buy list together with residential. We therefore anticipate a further spurt in activity and short-term capital growth, but with a caution that an inflection point for yields could be around the corner by 2022.
Smaller units in urban areas, either serving last mile deliveries where Amazon are at the forefront together with DPD, Hermes and DHL, or other businesses such as dark kitchens should remain in a structural supply-demand imbalance, with ongoing growth prospects and competition from residential use sometimes as an alternative supporter of value. So should self-storage, which provides a low overhead solution for start-up online retailers
Sustainability finally to come to the fore
Responsible investment will rise up the agenda, with investors asking increasing questions about environmental, social and governance (ESG) issues at companies they own, spreading into considerations around the assets they own.
Assuming the UK presses ahead with a new-zero carbon target for 2030, the residential sector, in particular, will take note – as it accounts for 14% of the UK’s carbon emissions, as part of the overall built environment which accounts for 40% of carbon emissions.
For existing buildings, owners and occupiers alike will introduce policies on integration and sustainability into their investment risk assessments. Green leases will come to the fore, requiring both landlords and tenants to cooperate on sustainability initiatives.
Beyond 2021
2021 is set to become a defining year. For those businesses which survive the inevitable challenging winter months, the pace of change and business confidence should grow, with some economic forecasters optimistic about the longer-term outlook.
Some predictions suggest that the UK economy will return to its pre-pandemic size by 2025, and back to its previous trend later in the decade.
If, as some economic forecasters predict, we have a background of low, or lower, interest rates in the decade ahead of us, multi-asset investors and others can be expected to reduce their holdings in bonds, in favour of property given an unusually high risk premium over ten year government gilt yields. Consequently, property yields in sustainable sectors will continue to decline and values rise.
A return to rebalancing the UK economy, with the longer-term trend of London’s economic performance no-longer out-performing the regions.
The challenge:
- The outflow of London’s population from the professional classes
- Balanced by an increasingly younger international mix
- The City will retain its No1 mantel for financial services
- London will continue to be a favoured destination for overseas investment
In a post-Brexit world, if the Government decides to undertake a bit of fiscal engineering, not only would it make Britain more attractive to overseas investors (Singapore-on-Thames) but it could stimulate overseas investment into green technology manufacturing in the Midlands/North - thereby creating jobs and meeting their ‘Leveling up’ agenda. The latter would appease the Red Wall MPs and the right wing of the party.
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.
