Steady State
by Sukhdeep Dhillon
The Best in 2019
North West logistics total returns are forecast to post 7.0%
It will be generated by the strongest capital growth in the UK and Ireland at 3.0%
All sectors and locations face yield expansion, though Dublin offices and UK logistics will remain flat at 4.00%
North West logistics will lead rental growth at 3.0%
Investors are showing signs of caution in the unfolding events surrounding Brexit. With the leave date pushed to October 2019, uncertainty will remain heightened, which may encourage investors to stall key decisions, especially on Central London offices. Until then, the investment market remains in a 'steady state' of activity
A similar state is also expected for the office occupational market. Central London offices defied predictions of letting collapse, with 2018’s total take-up 22% above the long-term average. Nonetheless, London is not the best performing asset in 2019 (1.50% prime total return), with return for the market only marginally better at 2.1%. Central London returns only regain traction towards the end of the forecast period with restoration of capital growth by 2023 (5% prime).
Office markets outside of London fare best. Edinburgh, in particular, stands out with prime return of 5.7% in 2019 and 4.3% pa for the 2019-23 forecast period. Market returns (5.2% pa) are higher, supported by income return of 7.2% pa over the period.
Dublin will see good performance in 2019 (4.0% prime). Fall back in capital growth in the middle of the forecast period reduces the mean prime return to 1.7% pa over 2019-2023. Dublin market returns (1.6% pa) will be lower still, though income returns will be stable at 5% pa on average.
Central London begins the forecast period with the lowest yields at 3.50% and may show the smallest shift of 10 bps to 3.60%. Dublin offices will remain stable at 4.00% in 2019 before expanding by 55 bps. We are anticipating some reduction in prime rental growth outside of London over the five-year forecast period, below 1% pa on average and negative in Manchester (-0.1%) and Dublin (-0.6%).
UK logistics is likely to post the strongest returns in the UK and Ireland region in 2019 led by the North West (7.0%) and Heathrow (6.5%). Over the forecast period, Heathrow logistics will produce the most robust performance at 4.9% pa on average. Capital growth will be low on average over 2019-2023, but yields will expand very slowly by 25 bps.
Logistics and retail are intrinsically linked, with logistics performing well from rapid growth of e-commerce; this will translate into rental growth of between 1.7% and 2.0% pa on average over the period. Despite high occupier demand, the industry's low margins inhibit sharp rental acceleration.
London retail ranks towards the bottom for prime total return in 2019 (-3.5%). Although the role of physical outlets is diminishing, Central London prime remains somewhat sheltered because it is a global city. This is reflected in the yield differential between London (3.15%) and cities such as Manchester (4.60%). Dublin’s yield is low at 3.25% though it is expected to expand the most, at 55 bps, by 2023.
Dublin’s prime total return is more solid at 3.7% pa over the forecast as a whole. The most consistent positive rental growth for UK and Ireland also comes from Dublin retail (+3.3% pa over 2019 – 2023) which has seen new brands attracted to major shopping centres and prime high street units.
Risk to the Forecast
Deep uncertainty about the final Brexit arrangement means there is potential for a radically different performance outcome for UK and Ireland.
However, the UK's resilience since the Brexit vote, particularly take-up in Central London offices surprised many to the upside.
The majority of Brexit tail risk is already priced into asset markets, so considerable upside exists if agreement is reached.