20
INVESTMENT BRIEF The definitive guide to UK commercial property investment Winter 2019 geraldeve.com
INVESTMENT BRIEFThe definitive guide to UK commercial property investment
Winter 2019
geraldeve.com
2 INVESTMENT BRIEF
Executive Summary 3
UK Economy 4
All Property 7
Offices 8
Retail 10
Industrial 12
Alternatives 14
Outlook 16
Forecasts 17
Further Insight 18
Contacts 19
CONTENTS
The UK economy avoided recession in Q3 but has been buffeted by weak global growth and Brexit-related uncertainty. A range of higher frequency indicators suggest that the underlying pace of activity was weak, notably manufacturing.
Total commercial property investment for Q3 was £12.2bn – the highest quarter for 2019 but lower than any in 2018 and investment remains historically subdued. The Q3 tick-up was driven by the Alternatives sector, with some exceptional portfolio deals.
EXECUTIVE SUMMARY
EXECUTIVE SUMMARY 3
The central scenario is a so-called orderly Brexit in 2020 after the December general election. There continues to be domestic investment demand for UK commercial property, an attractiveness for overseas buyers, and it is hoped that the emergence of greater clarity will be positive for investment volumes, which we expect to pick up in 2020.
Commercial property annual total return is set to fall to a low point of 1.6% in 2019, though the improvement in 2020 will be only to 2.6%. Income return is set to partially offset expected negative capital growth that will result from yield softening across most property segments.
All Property annual total return was 2% in Q3 – the lowest return since Q3 2009 and the fallout from the global financial crisis. On a more encouraging note, this marked an unprecedented 40th quarter of consecutive positive annual total returns.
For Offices, a growing disconnect between pricing expectations of buyers and sellers reduced the number of transactions in 2019 to a decade low. Overseas investors continue to dominate central London investment, increasingly targeting long income. Over the medium term, demand and supply dynamics favour key UK regional office markets rather than the more cyclical London markets; consequently the yield gap between them has almost halved.
Retail investment was extremely low in Q3 – one of the few times historically where the total has been below £1bn. The recent sharp increase in retail yields was in part a ‘structural’ outward shift, owing to a sustained shift in shopping patterns. This additional shift was an estimated 81bps, which eroded a further 11% from retail capital values. Nevertheless, since the current rental downturn has not been caused by a recession-generated collapse in consumer demand, though longer in duration, the fall in real retail rents in this cycle is likely to be shallower than previous cycles.
For Industrial, a sharp fall in portfolio deals reduced the average transacted size to a seven-year low in Q3. Yield stabilisation means the dominant total returns over the other property segments have now mostly fallen out of the figures. Off-prime yields have softened as investors focus on long income and the best assets, such as in London, where values have held better. With a stronger future rental growth profile we expect multi-let yields to follow a yield path below distribution warehouses for the first time on record.
4 INVESTMENT BRIEF
UK quarterly GDP growth continued to be volatile in Q3, with the economy buffeted by weak global growth and Brexit-related uncertainty. The Q2 quarterly figure was confirmed as -0.2% following the fallout from Brexit-related stockpiling in Q1 and a drag on manufacturing output from some car makers that brought forward their annual summer shutdowns to April.
The Q3 first estimate was +0.3%, meaning the UK avoided a technical recession. This was arguably boosted by further precautionary stockpiling ahead of the 31 October Brexit deadline. More broadly, however, a range of higher frequency indicators suggested that the underlying pace of activity was weak.
For example, the CIPS manufacturing survey in October reported that firms increased stock levels and their clients frontloaded orders for export ahead of the now postponed October 31 Brexit deadline. Otherwise most indicators remained subdued, with weaker inflows of domestic orders, production continuing to fall and firms cutting back on employment.
We expect manufacturing employment growth to turn negative in 2020 and 2021, while services employment is set to be more benign. Within this, financial services employment is expected to change little, while professional, administrative and tech should make more positive contributions.
The economic outlook assumes an orderly Brexit after a general election as the base case. In this scenario, GDP growth is expected to be only 1.1% in 2020, with consumer spending the main driver. An increase in household spending power is forecast for the medium term, following a pick-up in wage growth and a cooling of inflationary pressures. Consumer spending growth should also strengthen in 2021 when the four-year welfare freeze comes to an end.
Weaker international commerce and greater trade protectionism means net exports are set to detract from GDP growth in 2019, offset to some extent by domestic company stockpiling. A small exports pick-up is expected in 2020 before the undervalued pound rises following some greater certainty surrounding Brexit, which will neutralise the contribution to GDP growth over 2021-22.
Typical UK company finances are reasonably healthy, but the protracted political and economic uncertainty means that business investment is still below its late-2017 peak. This reluctance to spend is likely to continue and investment is only really likely to contribute meaningfully to GDP growth from 2021.
UK ECONOMY
Source: Oxford Economics
-0.4
-0.2
0.6
0.4
0.2
0
0.8
1.0
1.2
Q4
2012
Q3
2019
Q2
2013
Q4
2013
Q2
2014
Q4
2014
Q2
2015
Q4
2015
Q2
2016
Q4
2016
Q2
2017
Q4
2017
Q2
2018
Q4
2018
Q1 2
013
Q3
2013
Q1 2
014
Q3
2014
Q1 2
015
Q3
2015
Q1 2
016
Q3
2016
Q1 2
017
Q3
2017
Q1 2
018
Q3
2018
Q1 2
019
Q2
2019
%
UK quarterly GDP growth
Source: Oxford Economics
Consumer spendingInvestment
Net trade
Government consumptionOther (including inventories)GDP growth
-1.5
-1.0
0.5
0
-0.5
4.0
20212018 20191997-2007
2007-2017
3.5
1.0
1.5
2020
3.0
2.5
2.0
% pts
UK contributions to GDP growth
The economic outlook assumes an orderly Brexit after a general election as the base case. In this scenario, GDP growth is expected to be only 1.1% in 2020, with consumer spending the main driver.
2014 2015 2016 2017 2018 2019 2020 2021
GDP growth 2.6 2.4 1.9 1.9 1.4 1.3 1.1 2.0
Consumer spending growth 2.5 2.9 3.8 2.3 1.6 1.2 1.1 1.9
Manufacturing employment growth 2.1 0.6 0.1 1.8 1.1 0.3 -2.4 -1.0
Services employment growth 3.2 1.8 1.7 0.5 0.6 1.7 0.7 1.3
10-year bond yield 1.8 2.0 1.3 1.3 1.3 0.7 1.1 1.6
RPI inflation 2.4 1.0 1.7 3.6 3.3 2.6 2.4 2.9
Key macroeconomic variables: history and forecastSource: Oxford Economics
UK ECONOMY 5
The Bank of England’s base rate was kept on hold in November, but the minutes from the MPC meeting suggested that it could be cut if political developments cause more Brexit-related uncertainty to persist. Assuming Brexit is orderly, the base rate should remain at 0.75% until the end of 2020, with increases of 25bp a year thereafter. The highly uncertain and low interest rate environment means that very low bond yields are expected to rise only very slowly.
6 INVESTMENT BRIEF
The volume of underlying traded commercial real estate remained at historic lows in Q3 while the political and economic paralysis continued and another Brexit deadline passed.
The total for the quarter was £12.2bn – the highest for 2019 but lower than any in 2018. The quarterly increase was driven by the Alternatives sector, with the £600m and £400m sales of the Swift student accommodation portfolio and four retirement villages.
Alternatives was the largest individual sector for investment in Q3 for only the third time, previous quarters being Q1 2019 and Q1 2015. Clearly this sector has become more significant as the investment volumes for the others have fallen back. Investment in Retail in particular in Q3 was extremely low – one of the few times historically where the total has been below £1bn.
The rolling annual total return fell again in Q3 to only 2%, as the yield impact component of capital growth detracted more heavily. This was the lowest quarter since Q3 2009 and the fallout from the global financial crisis. On a more encouraging note, Q3 marked an unprecedented 40th quarter of consecutive positive annual total returns.
ALL PROPERTY
ALL PROPERTY 7
Sources: Property Data, Gerald Eve
IndustrialO�ce
RetailAlternative
0
5
Q3
2012
20
15
10
25
Q3
2019
Q4
2012
Q2
2013
Q4
2013
Q2
2014
Q4
2014
Q2
2015
Q4
2015
Q2
2016
Q4
2016
Q2
2017
Q4
2017
Q2
2018
Q4
2018
Q1 2
013
Q3
2013
Q1 2
014
Q3
2014
Q1 2
015
Q3
2015
Q1 2
016
Q3
2016
Q1 2
017
Q3
2017
Q1 2
018
Q3
2018
Q1 2
019
Q2
2019
£ billion
Quarterly investment into UK commercial property
Sources: MSCI, Gerald Eve
Income returnEquivalent yield impact
Rental value growthTotal return
-5
5
Q1 2
013
20
15
10
25
Q3
2019
Q2
2013
Q4
2013
Q2
2014
Q4
2014
Q2
2015
Q4
2015
Q2
2016
Q4
2016
Q2
2017
Q4
2017
Q2
2018
Q4
2018
Q3
2013
Q1 2
014
Q3
2014
Q1 2
015
Q3
2015
Q1 2
016
Q3
2016
Q1 2
017
Q3
2017
Q1 2
018
Q3
2018
Q1 2
019
0
Q2
2019
%
Annual total return and components
The All Property annual total return was 2% in Q3, marking both the 40th consecutive quarter of positive annual returns, but also the lowest since Q3 2009.
8 INVESTMENT BRIEF
Heightened uncertainty around Brexit and a growing disconnect between pricing expectations of buyers and sellers have reduced the number of office transactions in 2019 to a decade low
Whilst investment activity remained remarkably buoyant in the two years following the Brexit referendum, the number of office transactions in the first three quarters of the year are down by 31% on 2018 - the fewest recorded at this stage of the year in the last decade. The equivalent transaction volume total was also 41% below the level recorded over the same period in 2018.
This drop off in activity is the result of a growing disconnect between pricing expectations of buyers and sellers, with those looking to buy a property expecting a greater discount in price due to the increased level of risk brought on by the current market conditions.
The largest drop-offs were in London and the regional UK cities, falling by 30% and 36%, respectively, whilst activity in the South East has declined by only 10%.
Overseas investors continue to dominate central London investment, targeting long income
Despite a drop in overseas buyers in 2019, particularly from China, Hong Kong, and South Korea, foreign investment continues to be the main source of demand. In the year to September 2019 this accounted for 70% of all transactions across central London.
With limited capital growth forecast in the short and medium term, overseas investors have increasingly targeted longer income in central London. Since 2015, the proportion of office purchases with more than 16 years remaining on the lease has increased significantly each year, and so far in 2019 over half of overseas transactions have been for longer leases.
This demand has also been reflected in the net initial yield profile, with the average transacted yield for an office with less than 10 years of income remaining increasing over the last two years to 5.1%, whilst the average transacted yield for an office with more than 16 years remaining has fallen to 3.6%.
OFFICES
Sources: Property Data, Gerald Eve
Q1-Q3Q4
0
300
600
500
400
1000
20192013
900
700
800
2014 2015 2016 2017 2018
200
100
Number of UK office transactions
Sources: Property Data, Gerald Eve
Less than 16 years income Greater than 16 years income
0
30
60
50
40
100
20192013
90
70
80
2014 2015 2016 2017 2018
20
10
%
Proportion of London o�ce overseas investment by length of income
The number of office transactions in the first three quarters of the year are down by 31% on 2018 – the fewest recorded at this stage of the year in the last decade.
Late cycle demand and supply dynamics favour key UK regional office market outperformance…
Central London has one of the world’s most liquid, transparent and popular investment markets. Over the past 10 years, this has generated strong yield compression and relatively high total returns.
However, at this late point in the investment cycle it is now the key regional centres that have outperformed and this is set to continue over the medium term. Greater risk aversion in recent years amongst developers has limited new supply to these regional markets, whilst increased demand from occupiers relocating out of London and the South East, and a significant amount of development space taken by HMRC’s consolidation scheme, has bolstered the overall fundamentals.
This has drawn a wide range of investors to the regional cities, compressed yields down to record lows and driven capital value growth.
…consequently, the yield gap between London and the rest of the UK has almost halved
The yield gap between London and the key UK regions has reduced significantly. Competition for regional offices, particularly in Manchester and Birmingham, has been keen, resulting in a surge of investment in recent years, with 2019’s lack of activity attributed largely to a shortage of sellers.
OFFICES 9
Sources: MSCI, Gerald Eve
Central LondonRest of the UK
3.0
3.5
4.0
4.5
5.0
5.5
6.0
2016 2017 2018 2019
204 bps 110 bps
%
Net initial yield by region
Sources: MSCI, Gerald Eve
LondonUK regions excluding South East
0
5
25
20
10
15
2016 2017 2018 2019 202020152014
%
Annual office total return, London and regions
Late cycle demand and supply dynamics have drawn a wide range of investors to the regional cities, compressed yields down to record lows and driven capital value growth.
10 INVESTMENT BRIEF
RETAIL
A significant structural outward shift in retail yields over and above what would ‘normally’ be expected
With consumer spending expected to hold firm over the next few years and the prospects for general retail sales appearing to be reasonably sound, the recent underperformance of UK retail property is not due to a weakening of consumer spending power, but instead the structural change in shopping patterns.
Following the normal cyclical pattern, the recent sustained negative outlook for retail rents means that the relative increased softening of retail equivalent yields was rational. However, given just how much yields have moved out in the current cycle, we have here sought to quantify how much of this yield shift is a result of the structural change to the sector over and above cyclical movements.
An econometric model that considers the individual effect of relative rental growth expectations to capture the relative movement in sector yields suggests retail yields ‘should have’ been around 5% in Q3 2019. However, retail yields ended Q3 2019 81bps higher than this. The estimated structural shift in the retail yield profile began in mid-2014 and has meant that capital values have fallen by an additional 11%.
This drastic structural outward pricing has driven down returns and curtailed investment volumes
On a rolling annual basis, investment into UK retail property has fallen every quarter since Q3 2016. Investor confidence in the sector is very low while high profile administrations and CVAs dominate retail headlines. The retail investment assets that have traded have mostly been brought to market by institutions who are generally overweight in retail, with supermarkets proving to be the most traded segment by these type of vendors.
Sources: Property Data, Gerald Eve
0
2
8
6
4
16
Q2
2019
Q3
2011
Q4
2011
Q1 2
017
Q2
2017
Q3
2017
Q4
2017
Q1 2
018
Q2
2018
Q3
2018
Q4
2018
Q4
2010
Q1 2
011
Q2
2011
14
10
12
Q1 2
019
Q3
2012
Q4
2012
Q1 2
012
Q2
2012
Q3
2013
Q4
2013
Q1 2
013
Q2
2013
Q3
2014
Q4
2014
Q1 2
014
Q2
2014
Q3
2015
Q4
2015
Q1 2
015
Q2
2015
Q3
2016
Q4
2016
Q1 2
016
Q2
2016
Q3
2019
£ billion
Yield transition periodStart of change in expected and actual retail equivilent yields
Rolling 12 month retail investment volumes
Yield transition period
Sources: MSCI, Gerald Eve
Actual all retail equivalent yields Estimated structural all retail equivalent yields (including rent expectations)
4
9
Q3
2019
Q3
2005
Q1 2
006
Q3
2006
Q1 2
007
Q3
2007
Q1 2
008
Q3
2008
Q1 2
009
Q3
2009
Q1 2
016
Q3
2016
Q1 2
017
Q3
2017
Q1 2
001
Q3
2004
Q1 2
005
8
7
6
5
Q3
2001
Q1 2
004
Q1 2
018
Q3
2018
Q1 2
002
Q3
2002
Q1 2
003
Q3
2003
Q1 2
010
Q3
2010
Q1 2
011
Q3
2011
Q1 2
012
Q3
2012
Q1 2
019
Q1 2
013
Q3
2013
Q1 2
014
Q3
2014
Q1 2
015
Q3
2015
%
Start of change in expected and actual retail equivalent yields
Retail equivalent yields have moved out an additonal 81bps over and above what would have been expected under ‘normal’ cyclical movements and with the hindsight of rental growth
Retail actual and ‘structural’ shift in equivalent yield
RETAIL 11
In Q3 2019, annual retail rental growth was -4.2%, which drove annual total returns to -5.6%. On an annual basis, nominal retail rental values have fallen for five consecutive quarters and, given the time lag in valuations and the lack of comparable evidence for valuers, even this fall may be understating the reality of what is happening.
The fall in real rental values could be more modest than previous cycles, albeit longer in duration
This rental downturn is fundamentally more to do with the structural change in shopping patterns, rather than a result of any recession-generated collapse in consumer demand, as we have seen in previous periods of falling rental growth. Compared with the other two recent periods of sustained retail rental decline in 2007 and 1989, the fall, in real terms, has been shallower this time around.
We believe that retail rents have further to fall over the medium term, given the ongoing store closures and CVAs, and because there will be a significant lag in the activity feeding through to the valuations figures.
Though longer in duration, the fall in real retail rents in this cycle is likely to be shallower overall than previous downturns. This outlook is compounded by the extremely low levels of retail development over the past five years. However, it is also highly susceptible to downward revisions if underlying consumer demand falters.
Sources: MSCI, Gerald Eve
Income returnEquivalent yield impact
Rental growth
-15
0
-5
-10
20
5
10
15
Q3
2014
Q4
2014
Q1 2
015
Q2
2015
Q3
2015
Q4
2015
Q1 2
016
Q2
2016
Q3
2016
Q4
2016
Q1 2
017
Q2
2017
Q3
2017
Q4
2017
Q1 2
018
Q2
2018
Q3
2018
Q4
2018
Q1 2
019
Q2
2019
Q3
2019
%
UK retail annual total returns and components
Total return
Sources: MSCI, Gerald Eve, Oxford Economics
Peak = 1989Peak = 2007
Peak = 2016Forecast
Years from peak
75
105
1
85
100
95
90
2 3 4 5 6 7 8
80
Peak = 100
Real retail rental value growth cycle comparisons and forecast
Sources: MSCI, Gerald Eve
Peak = 1989Peak = 2007
Peak = 2016Forecast
Years from peak
85
110
1
100
95
90
2 3 4 5 6 7 8
105
Peak = 100
Nominal retail rental value growth cycle comparisons and forecast
Ongoing buyer and seller conservatism has brought about a sharp fall in portfolio and regional deals that have reduced the average transacted size to a seven-year low…
Quarterly industrial investment edged up in Q3 though this was still very low compared with the market peak in 2018. There was an increased number of transactions in Q3, thus the average transaction size fell again to under £8m, which was the lowest in seven years.
There is still plenty of investment money available to target the sector in principle, and the investor view of the occupier market is still relatively positive. Industrial rental growth expectations are stronger than for offices and retail, particularly for the supply-constrained multi-let segment. However, protracted political and economic uncertainty has generated a more conservative and demotivated set of potential buyers that are more cautious in their attitudes towards covenants. Occupational voids are now more often viewed as a risk than the opportunity that they may have been 18 months ago.
…but London investment has increased as investors focus on long income and the best assets
The recent drop-off in investment volume has affected all property sectors but it is especially noticeable in industrial, since 2018 was such a strong year for this sector. However, this has not occurred equally across all industrial geographies. Portfolio deals, for example, have fallen a very significant 71%, which has driven down the average industrial deal size recently.
London stands out as being different. In the flight to quality, multi-let assets with long unexpired income (particularly in London) are still desirable and will sell well. Trading has not fallen off for these assets and yields have held relatively firm despite being past the peak of the market. A recent example from Q3 is the Sergeant Industrial Estate in Wandsworth, sold for £28m off a 2.3% yield.
In contrast, single-let assets with 3-8 years of income have suffered by virtue of being neither prime nor sufficiently secondary for more opportunistic investors. For the most part, such assets have been made available off-market (particularly in more regional locations) and have not found buyers. In the instances of a successful transaction the price achieved has often been well below initial seller expectations (typically retail-led fund redemptions). Yields on these assets were considered to have come in too far in the previous cycle upswing and have thus drifted most significantly – as of Q3 up to 75bps from their peak.
12 INVESTMENT BRIEF
Sources: Property Data, Gerald Eve
20182019
0
400
1,000
800
600
1,200
PortfolioRest of the UKSouth EastLondon
200
£ million
+48%-53%
-24%
-71%
Average quarterly investment
INDUSTRIAL
Sources: Property Data, Gerald Eve
Multi-letDistribution warehouse
Average lot size (RHS)
0
1
5
Q2
2019
Q4
2016
Q1 2
017
Q2
2017
Q3
2017
Q4
2017
Q1 2
018
Q2
2018
Q3
2018
Q4
2018
Q3
2016
3
2
Q1 2
019
4
25
20
15
10
5
0
Q3
2019
£ billion £ million
Quarterly industrial investment
Occupational voids are now more often viewed as a risk than the opportunity that they may have been 18 months ago.
Industrial total return dominance has eased and distribution warehouse yields are on a higher course than multi-let for the first time
The unambiguous industrial inward yield shift of 2017 and 2018 and the associated positive impact on capital values that stimulated such dominant total returns over the other property segments has now fallen out of the figures.
Nevertheless, industrial still has the best returns of any asset class and, within this, multi-let has outperformed distribution warehouses. Since 2016 both segments have undergone a structural shift and yields are lower relative to other property segments than otherwise would be expected at this point in the cycle. The downward shift for multi-let has been greater, given the gentrifying transition of the underlying occupier profile.
Distribution warehouse and multi-let yields are now, for the first time, effectively at parity. Looking ahead, given the superior rental growth outlook for multi-let we anticipate distribution yields will drift higher than multi-let for the first time on record.
The expected average annual total return for the various industrial segments for the next three years is more muted than that achieved over the past 10, given the either flatlining or small outward shifts in yields expected over the short term.
Industrial is set to continue to outperform the other property segments, notably multi-let, with better prospects over the medium term the closer an asset is to the South East, particularly London.
INDUSTRIAL 13
Sources: MSCI, Gerald Eve
Multi-letDistribution warehouse
4.5
8.5
2013
7.5
5.5
7.0
6.5
6.0
8.0
5.0
2014 2015 2016 2017 2018 2019 2020 2021
%
Equivalent yield relativities between multi-let and distribution warehouse
Sources: MSCI, Gerald Eve
Industrial total returnIndustrial yield impactIndustrial rental growth and income return
Office total returnRetail total return
-10
25
Dec
17
Mar
18
Jun
18
Sep
18
Dec
18
Mar
19
Jun
19
Sep
19
Sep
16
Jun
17
Sep
17
20
-5
15
10
Dec
16
Mar
17
5
0
%
Industrial annual returns vs other segments
2019-21 2008-18
London Multi-let 6.8% 10.8%
South East Multi-let 6.4% 8.3%
Distribution Warehouse 4.8% 7.9%
Rest of the UK Multi-let 4.7% 6.5%
Average annual total returnSources: MSCI, Gerald Eve
In the flight to quality, multi-let assets with long unexpired income are still desirable and will sell well.
14 INVESTMENT BRIEF
The recent drop-off in investment activity has been significantly less for alternative property
Investment activity across the UK has been subdued so far in 2019, with transaction volumes 29% lower than they were over the same period in 2018. However, whilst the main commercial sectors have seen a significant drop off in activity, (industrial -42%, office -41%, and retail -33%), investor demand has been much more stable for the alternatives sector, with transaction volumes only 4% below what they were in 2018.
According to MSCI, all property capital values grew by only 0.6% in 2018, and we forecast them to decline by 2.9% in 2019, and 1.8% in 2020, largely due to negative performance from the retail sector. At this stage of the property cycle, with shortening income streams in many of the traditional markets, it is alternatives that arguably hold the greater investment potential.
Aside from student accommodation or build-to-rent residential, most alternatives leases are signed for at least 20 years. MSCI reports that retail and industrial lease lengths have fallen to 9.5 years and 6.8 years respectively, whilst offices have remained relatively flat since 2017 at 7.6 years. However, over the same period alternative asset leases have increased to over 39 years.
Not only is the income profile of the alternative sector longer, but the occupier base is generally also more defensive in nature. According to MSCI’s UK Risk Score, which assesses the likelihood that a company will cease operations without paying all its creditors over the next 12 months, occupiers in the alternative sector have the lowest risk of all commercial property sectors.
Alternative sector returns have regularly outperformed all property
Since 1981, alternative assets have outperformed the all property total return on 29 out of 38 years. As well as achieving strong positive total returns in good market conditions, the defensive qualities of the sector has made the properties more resilient during a recession. For example, all property capital values fell by 18.8% between 1990 and 1992, and 28.4% between 2007 and 2009, compared with alternatives which fell by 13.7% and 16.7% during the same periods.
ALTERNATIVES
Sources: Property Data, Gerald Eve
-45
-35
-20
-25
-30
0
Industrial
-5
-15
-10
O�ce Retail Alternative
-40
%
Comparison of transaction activity so far in 2019 compared with the same period in 2018
Sources: MSCI, Gerald Eve
Alternative outperformanceAlternative underperformance
-5
25
2017
1987
1989 1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
5
1981
1983
1985
20
10
15
0
2011
2013
2015
%
Long term gap between alternative and all property total returns
At this stage of the property cycle, with shortening income streams in many of the traditional markets, it is alternatives that arguably hold the greater investment potential.
ALTERNATIVES 15
Healthcare has overtaken hotels as the best-performing segment over the last year
Over the last five years, UK hotels have been the best performing segment within the alternative property sector, achieving an average total return of 10.8%. However, more recently UK healthcare has seen a surge in activity from both domestic and overseas investors, attracted by the segment’s strong fundamentals - demand underpinned by an ageing population, and, sustainable, long-term income. Over the last three years, investment into healthcare property increased by 73% compared with the three years prior.
According to Laing & Buisson, care homes are the largest single segment within the healthcare property sector and account for 29% of the total market by value. Historically, care homes were largely dominated by the public sector. However, the increase in demand from the private sector means that 94% of capacity is now privately owned, with the combined local authority and NHS capacity only 6% of total supply. With public sector unit costs running at double or more of the private sector equivalent, the public sector share of provision is expected to decline even further in the future.
The UK’s ageing population will be the main driver of growth in the healthcare segment in the future. According to Oxford Economics, the number of people over the age of 65 in the UK will increase by 21% over the next decade, and by 43% over the next 20 years. Such strong growth rates are likely to ensure that care homes and other property linked to the ageing population are likely to be key drivers of the UK healthcare sector.
Sources: MSCI, Gerald Eve
HealthcareHotel
LeisureResidential
0
2
12
1 year
10
6
8
4
3 years 5 years
%
Total returns by alternative property segmentSource: Laing & Buisson
0
2
16
Dent
istry
Priv
ate
heal
thca
re
Child
care
Men
tal h
ealth
hos
pita
ls
Care
hom
es fo
r o
lder
peo
ple
10
6
8
12
14
Hom
ecar
e an
d su
ppor
ted
livin
g
Adul
t spe
cial
ist c
are
4
£ billion
UK healthcare property market value, by segment
Over the last three years, investment into healthcare property increased by 73% compared with the three years prior.
The last quarter of the year is typically a busy one. However, with the UK general election on which so much depends falling on the 12th December, we expect more subdued investment volumes while the Brexit impasse continues. The central scenario is a so-called orderly Brexit in 2020 after the general election.
The business and investment community are relatively downbeat about any of the realistic potential outcomes, but this is already largely priced in. There continues to be domestic investment demand for UK commercial property, an attractiveness for overseas buyers, and, it is hoped that the emergence of greater clarity will be positive for investment volumes, which we expect to pick up in 2020.
Commercial property annual total return is set to fall to a low point of 1.6% in 2019, though the improvement in 2020 will be only to 2.6%. Income return is set to partially offset expected negative capital growth that will result from yield softening across most property segments.
The slight pick-up in all property total return in 2020 will be driven by retail, which will have had its most deeply negative year of falling rents and outward yield shift in 2019. Nevertheless, a further two years are expected before nominal rents stop falling and yields stabilise. Retail is still anticipated to generate the lowest returns of any property sector over the next three years, with shopping centres particularly affected.
The unambiguous industrial inward yield shift of 2017 and 2018 and the associated positive impact on capital values that stimulated such dominant total returns over the other property segments has now fallen out of the figures. However, industrial is still forecast to outperform over the next three years, with only really the non-core properties expecting much outward yield shift. In particular there is still strength in the exceptionally supply-constrained multi-let, and we expect distribution warehouse yields to drift above multi-let for the first time on record.
Offices are set to fair better than retail, though the more cyclical central London markets will pull down the overall office average in the short term. The South East office occupational markets should remain generally resilient, especially with the further erosion of supply through ongoing residential permitted development. However, the key regional centres are set to continue to outperform over the medium term. Limited new supply in recent years with increased occupier demand has bolstered the overall fundamentals and investor attractiveness.
16 INVESTMENT BRIEF
OUTLOOK
OUTLOOK 17
Sources: MSCI, Gerald Eve
2019-212008-18
-6
-2
4
2
0
6
8
10
12
Lond
on m
ulti-
let
Wes
t End
offi
ce
Mid
tow
n of
fice
City
offi
ce
Reta
il w
areh
ouse
Rest
of t
he U
K of
fice
Out
er L
ondo
n of
fice
Dist
ribut
ion
war
ehou
ses
Shop
ping
cen
tres
High
stre
et
-4
Sout
h Ea
st m
ulti-
let
Rest
of t
he U
K m
ulti-
let
Sout
h Ea
st o
ffice
%
Average annual total return, 2019-21 and 2008-2018Sources: MSCI, Gerald Eve
Income returnYield impact
Rental growth
-4
2
0
-2
12
4
2016 2018 2019 2020 20212017
Forecast10
6
8
%
All property total return and components
Total return
Total return
Income return
Yield impact
Rental growth
All Property 2.9% 4.5% -1.9% 0.3%
Retail -1.5% 5.8% -5.3% -3.0%
High Street -2.0% 4.4% -3.1% -2.7%
Shopping Centres -3.6% 6.1% -5.8% -3.5%
Retail Warehouse -1.2% 6.6% -4.5% -3.0%
Office 4.6% 4.1% -0.4% 1.6%
City Office 4.0% 3.8% -1.0% 1.0%
West End Office 4.6% 3.6% -0.8% 2.2%
South East Office 4.7% 5.0% -0.9% 1.7%
Rest of UK Office 5.1% 4.7% 0.4% 1.4%
Industrial 5.5% 3.6% -1.4% 2.8%
Multi-Let 6.2% 3.8% -1.0% 3.1%
Distribution Warehouse 4.8% 4.9% -2.3% 2.1%
Forecasts by main property segment: annual average total return and components (2019-2021)Sources: Gerald Eve, MSCI
FORECASTS
For more information on individual sectors, please see the following publications:
London MarketsSummer 2019
Multi-LetSummer 2019
LONDON MARKETSThe definitive guide to
Summer 2019
geraldeve.com
MULTI-LETThe definitive guide to the UK’smulti-let industrial property market
Summer 2019
geraldeve.com
18 INVESTMENT BRIEF
South East Office Investment BulletinQ3 2019
SOUTH EAST OFFICE INVESTMENT BULLETINQ3 2019
geraldeve.com
Prime Logistics BulletinQ3 2019
PRIME LOGISTICSThe definitive guide to the UK’s distribution property market
Q3 2019 Bulletin
geraldeve.com
FURTHER INSIGHT
Healthcare
Richard Moir PartnerTel. +44 (0)20 7333 6281Mobile +44 (0)7771 [email protected]
Regional Investment
Callum Robertson PartnerTel. +44 (0)16 1259 0480Mobile +44 (0)7810 [email protected]
South East Offices
Guy Freeman PartnerTel. +44 (0)20 3486 3471Mobile +44 (0)7796 [email protected]
Leo Zielinski PartnerTel. +44 (0)20 3486 3468 Mobile +44 (0)7980 [email protected]
Portfolios
Alternatives/Long income
Richard Lines PartnerTel. +44 (0)20 7333 6274Mobile +44 (0)7825 [email protected]
Lloyd Davies PartnerTel. +44 (0)20 7333 6242Mobile +44 (0)7767 [email protected]
London offices
John Rodgers PartnerTel. +44 (0)20 3486 3467Mobile +44 (0)7810 [email protected]
UK Capital Markets
Nick Ogden PartnerTel. +44 (0)20 3486 3469Mobile +44 (0)7825 [email protected]
Industrial & Logistics
Valuations
Michael Riordan PartnerTel. +44 (0)20 7653 6828Mobile +44 (0)7796 [email protected]
Leisure
Charles Wilford PartnerTel. +44 (0)20 7333 6215Mobile +44 (0)7774 [email protected]
Leisure
Daniel Anning PartnerTel. +44 (0)20 7333 6374Mobile +44 (0)7776 [email protected]
Will Kirkpatrick PartnerTel. +44 (0)20 7333 6228Mobile +44 (0)7836 [email protected]
Hotels
Research
Alex Dunn AssociateTel. +44 (0)20 3486 3495Mobile +44 (0)7917 [email protected]
Research
Ben Clarke Senior AssociateTel. +44 (0)20 7333 [email protected]
Research
Steve Sharman PartnerTel. +44 (0)20 7333 6271Mobile +44 (0)7508 [email protected]
CONTACTS
CONTACTS 19
Corporate Finance
Darren Baker Mobile +44 (0)7508 [email protected]
London (West End) 72 Welbeck Street London W1G 0AY Tel. +44 (0)20 7493 3338
London (City)46 Bow Lane London EC4M 9DL Tel. +44 (0)20 7489 8900
Birmingham45 Church Street Birmingham B3 2RT Tel. +44 (0)121 616 4800
Cardiff32 Windsor Place Cardiff CF10 3BZ Tel. +44 (0)29 2038 8044
Glasgow140 West George Street Glasgow G2 2HG Tel. +44 (0)141 221 6397
Leeds1 York Place Leeds LS1 2DR Tel. +44 (0)113 204 8419
ManchesterNo1 Marsden Street Manchester M2 1HW Tel. +44 (0)161 259 0450
Milton KeynesAvebury House 201-249 Avebury Boulevard Milton Keynes MK9 1AU Tel. +44 (0)1908 685950
West Malling35 Kings Hill Avenue West Malling Kent ME19 4DN Tel. +44 (0)1732 229420
Disclaimer & copyrightThis brochure is a short summary andis not intended to be definitive advice.No responsibility can be accepted forloss or damage caused by reliance on it.
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The reproduction of the whole or partof this publication is strictly prohibitedwithout permission from Gerald Eve LLP
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OFFICES
