After making a range of sporting, economic and political predictions over the course of the last two Sundays, (all of which remain on course, we might add!), this edition of The Weekly focuses on Bull and Bear's expectations for the UK property market in 2019. Covering this in a way that doesn’t resemble War and Peace is almost as hard as making the predictions themselves. However, in keeping with previous editions, Bull and Bear have concentrated on the ten issues that everyone wants to know the answers to. Wish them luck, as calling the market for 2019 is certainly no easy task:
1. Investment Volumes will reach £50bn in 2019. However this will show a significant decline on 2018 (£61.8bn). According to Property Archive, commercial property investment in January 2019 totalled just £2.6bn (£5.3bn in January 2018), the weakest month since the immediate aftermath of the EU Referendum in June 2016. January 2019 also marked the lowest monthly total of transactions (80) since late 2012 and pushed the twelve-month roiling average to its weakest in five years. Investors are, understandably, currently sitting on their hands awaiting greater clarity on Brexit, but assuming Bull and Bear's prediction is correct that there will be some form of Brexit deal agreed by the end of March, they expect there to be a material release of pent-up demand that is sitting on the side-lines watching with interest.
2. Yield compression across the main sectors is unlikely during 2019. LSH’s All Property average transaction yield reached an eleven-year low in December 2018 (5.34%), and it’s hard to envisage it falling any lower. In what will not be a shock to anyone, all the retail subsectors (other than for prime, long-let supermarket investments), have experienced significant yield softening over the last twelve months. The outlook is for further weakness across the board. Yields are currently stable for prime offices and industrials, although there are justifiable concerns for the future pricing of secondary assets which are likely to drift outwards as investors focus on the security of their income.
3. Despite Brexit, the UK will remain an attractive investment destination for overseas investors. The Japanese and South Koreans are expected to be at the front of the queue. Allocations to real estate are on the up, both globally and domestically, and compared with other global locations, the UK continues to offer relative value, not to mention the security, liquidity and transparency of investing here and, for now at least, a beneficial exchange rate. London remained the world’s most popular destination for cross-border investment into real estate in 2018 and Bull and Bear do not expect this to change in 2019. Office investment yields for top assets in the German cities of Frankfurt, Berlin and Munich are now all sub-3%. A well-let City of London office building at 5.00% therefore looks like a bit of a bargain in comparison!
4. Talking of Central London offices, Bull and Bear expect this market to once more confound negative expectations. Of course, performance in 2019 will be closely correlated to the UK’s immediate political and economic future, but we shouldn’t forget that office take-up rose 10% year-on-year in 2018, whilst at £16.9bn, Central London office investment volumes surpassed each of the previous two years (and was 26% above the ten-year average). Bull and Bear’s view is that in 2019, headline rents will remain stable in the West End, Midtown and South Bank, underpinned by low vacancy. However the City, Docklands and West London sub-markets are likely to witness a modest decline in rents (and see increased tenant incentives), reflecting Brexit uncertainty, relatively higher vacancy rates and several imminent substantial office completions.
5. Office rents in the UK’s key regional markets will see modest rental growth during 2019. Grade A availability across the CBDs of the major regional cities remains limited. 2018 was a record year of take-up across JLL’s ‘Big Nine’ office markets, amounting to 10.7 million sq. ft. Co-working operators were a major driving force behind that. The lack of prime stock continues to impact on headline rents which now average £30.33 per sq. ft. With an average rent-free period of 20 months on a ten-year term, this equates to a net effective rent of £26.03 per sq. ft, an increase of 4.1% over the past 12 months and 30% over five years. According to MSCI, average annual regional office rental growth was 1.3% to November 2018. Bull and Bear expect a similar level of rental growth over the next year.
6. The woes of the UK high street will continue. Already this year, the likes of HMV, Patisserie Valerie and Oddbins have gone pop, and according to the Centre for Retail Research, retail job losses are expected to exceed 160,000 job losses. Ouch! So far, falling investment valuations have focused on deteriorating investor sentiment, but inevitable further readjustments are in the offing as retail rents start to fall. Whilst there is undoubtedly more pain to come, it’s not inconceivable that, by the end of 2019, the pricing of quality retail assets in proven locations will start to look like an attractive investment proposition again. As for secondary and tertiary retail units, the future looks bleak indeed.
7. The industrial sector will continue to outperform. The undisputed ‘boss sector’ of 2018, industrials delivered a total return of 16.4%. No-one is expecting such a stellar return this year as capital appreciation will be minimal and rental growth rates will slow. But nonetheless industrial occupier demand will remain strong. According to the quarterly MSCI Index, All-Industrial rents increased by 4.6% year-on-year in Q4 2018, down slightly from 5% year-on-year in Q3, but well above the 0.5% growth for All Property. Further industrial growth in 2019 is expected (2.1% pa over the next four years according to JLL) and investors will continue to factor this in on their pricing. Given prime logistics yields in London currently stand at a remarkable 3.50%, investors will certainly want that rental growth to materialise!
8. 2019 will be a tough year for the UK’s housing market. Despite high employment levels, improving real wage growth and low interest rates, the housing market is shakey and will continue to be so throughout 2019. However, away from the sales side, an under-supply of homes for rent will continue to underpin respectable rental growth. Whilst the institutional investor is now becoming a significant and increasingly important component of new housing delivery, the number of operational build-to-rent units remains a tiny fraction of the UK’s private rented stock. Significant further institutional investment into this burgeoning sector should be expected during 2019.
9. 2019 will be all about income. Demand for secure, long-let, indexed-linked assets will become even more insatiable this year. Therefore, the alternatives sectors (hotels, student accommodation, health care and the like), which are typically long-leased, will experience significant investor demand. Investment in the specialist sectors made up 17% of total investment volumes in 2018. This year volumes are anticipated to exceed this, with the focus on demographic, structural and technological changes remaining fundamental to driving strong performance.
10. Any finally, the big one. Bull and Bear's total return prediction for 2019. Limited, if any yield compression, continued falling retail values and a downward readjustment in the value of many secondary assets all point towards a lower All Property Total Return than the 6.0% that was delivered in 2018. If we look at the most recent IPF Consensus forecast (November 2018), the UK property industry is expecting a total return of 3.00%. That feels a tad light to us. Remembering we got 2018’s prediction 100% spot on(!!!), we are predicting 3.75% this year. Fingers crossed.
So where does all this leave us? In short, Bull and Bear's view for 2019 is that the most resilient investments will be in the best locations in the best UK cities; the best locations will attract the best tenants; and demographic and infrastructure-led assets will prosper the most. Then again, we may find ourselves with a No Deal Brexit in a little over a month’s time and all the predictions that Bull and Bear have made over this and the last two Sundays may prove to be not much more than moonshine!