Brexit dynamics rapidly changed over Q2, as the UK faces a change in leadership with a new PM and with an increased chance of a no deal scenario coming to pass. Against this backdrop it is unsurprising that investment activity was subdued over the quarter.
The H1 2019 total represents a 35% drop on the five year H1 average; all sectors are down on the five year average. The largest shortfall in percentage terms was the retail sector which was 50% (or £2.4 billion) down on the five year H1 average. Office transaction volumes were down the most (by £4.3 billion - 40% down). The extent of the drop-off in office transactions is evidenced when considering that a single sale accounts for 18% of total H1 office transactions (£1.1 billion sale to Citibank of their Canary Wharf HQ).
In Q2 2019 volumes continue to be impacted by a slowdown in deals >£100 million, reflecting the difficulty in executing real estate investment strategy. Investors remain cautious, particularly cognisant of the current political risks. Transactions >£100M have averaged around £6.3 billion per quarter, over the last 3 years; in Q2 2019 only £2.9 billion transacted in this segment, a shortfall of 54% (or £3.4 billion worth of sales).
Q2 Central London office take-up has remained broadly on trend, and rents in key sub-markets continue to record rental growth. Typically the occupier market and transaction volumes are highly correlated (0.76), the recent Brexit developments have softened appetite to complete transaction activity on the capital markets side, rather than the occupier side. Take-up in Central London is in line with the long-term half year average for H1 2019 (compared to a 40% fall in Central London investment volumes).
The resilience of the London (and broader UK) occupier market has been underpinned by sustained jobs growth, particularly in the office occupying sectors. With corporate Britain expanding headcount, the demand for office space has been healthy, this improves the prospects for income security for asset holders. The security on income is also buttressed by a restrained level of office development in the capital, minimising the risk of a supply-side deterioration in the vacancy rate. Encouraging activity has already been observed in Q3. Since the beginning of July, BNPPRE has identified over £1.7 billion worth of sales in the West End alone, indicating that markets remain liquid. In the city the story is much the same, with 5 transactions in July >£100M already, exceeding the 3 deals over >£100 in the whole of H1.
Given the low transaction volumes, overseas investment appetite remains; overseas investors acquired £4.6 billion in Q2 (and £9.5 billion in H1 2019), representing about 53% of all transaction activity so far 2019, slightly above the five year average.
Over the quarter gilt rates fell below 1%, increasing the risk premium on UK real estate, and at one stage were 18 basis points from their all-time low in August 2016. A similar trend was observed in the bond rates of countries that invest the most capital into UK real estate. The widening spread to bonds should encourage further allocation into real estate, especially for transparent markets with scale such as the UK.
Another pull-factor for overseas investors is the recent trajectory of Sterling. Since the referendum the pound has experienced drops in excess of 10% against the Euro and US dollar, with investors from overseas receiving an added affordability benefit, particularly for investors with a bias for mean reversion in their forecast currency models. Investors from US and Asia (specifically China/Hong Kong) have remained active in H1 2019, transacting £5.1 billion (or 26% of total transaction volume), proportionally in line with recent trends.