FULL REPORT
Things are beginning to look up for the UK economy. As the UK transitions out of lockdown towards the first phase of easing restrictions, many indicators are showing positive signs.
Business sentiment is on a high, with the latest PMI data coming in much stronger than anticipated. The manufacturing index increased from 55.1 to 57.9 and the services index from 49.5 to 56.8 (anything above 50 indicates expansion). Consumer confidence also increased at the fastest rate in the first three months of 2021, reaching a 13-month high. This clearly shows sentiment has shifted and is improving rapidly.
BNP Paribas have revised UK GDP growth forecasts, with growth now expected to reach 6.1% in 2021 (previously: 4.0%). This includes a much smaller decline of 2.8% q-o-q in GDP in the first quarter (previously: -5.7%). The risks to the forecasts are skewed to the upside, which is a welcome change from the previous forecasts, implying higher probability of stronger growth and potentially higher inflation than the base case forecasts.
Further positive signs were seen in the labour market, with vacancies increasing by 16% in March compared with February 2021. Despite the improvement in vacancies, just over 4.6m people are still supported by the Job Retention Scheme. With the Furlough scheme now running for a full year, longer than many had anticipated, the full effect of the pandemic on the labour market may still take time to materialise. As the UK lifts restrictions and the service sector begins to re-open, we are likely to see many of those furloughed and employed in the hospitality sector return to work. Realistically not all will return to a job, therefore we are likely to expect an uptick in the unemployment rate, especially as government support is withdrawn.
Annual pay growth also looks strong, with total average weekly earnings increasing by 4.8%. It is worth noting, however, that this growth may be largely attributable to the fall in the proportion of low-paid workers, which will push the average up. The ONS estimates the net impact of the recent job losses has increased the average salary by approximately 1.9%, as a result the true growth in wages is around 2.5% for total and regular pay.
It was a mixed picture for the market in Q1. Despite increasing investor confidence in line with improving business sentiment, transaction volume reached just £10.4bn, 35% down on Q1 last year and 23% below the ten-year quarterly average. The office sector recorded just over £2.0bn of volume, half of Q1 2020 levels and a 22% drop in Q1 2019. This generally reflects the restrictions on international travel and landlords withholding disposals during the strict lockdown measures at start of the year.
However, there were some encouraging signs. It was the quietest first quarter on record for the Central London market, but with investor demand still at record levels, prime yield compression is starting to come through. Of particular note was CBREGI’s acquisition of Atlantic House, EC1, wholly let to Hogan Lovells for another 5 years, for a sub-4% yield, showing investors are willing to pay strong pricing for best-in-class office product. Also in Central London, the sale of the Armani flagship store in Bond Street to Motcomb Estates for £95m / 3.1% was a welcome reminder that demand for well-located, high-quality retail assets remains strong.
It is also reassuring to see the return of activity in the student housing market, which saw almost £1.0bn of deals transact over the quarter according to PropertyData. Much of this was within large portfolios, most notably KKR’s sale of the Nido Portfolio to Greystar for £291m. With an 8.5% increase in university applicants so far this year, and landlords beginning to report encouraging reservation levels for 2021/22, we anticipate investment into this sector to continue to pick up as the year progresses.
The biggest success story, however, continues to be logistics. The sector had its busiest first quarter on record, with transaction volume reaching £3.2bn. Not only was this up 96% on Q1 2020 (the only sector to outperform Q1 2020), it was the second consecutive quarter that Industrial has outperformed offices. Prime logistics yields, at 3.50%, are now on a par with prime offices, and there are signs this could compress further in Q2. This is symptomatic of a gradual reallocation of institutional capital away from offices and retail towards industrial assets. Looking ahead, we expect the logistics sector to continue to increase its investment market share.
The UK economy is beginning to take its first steps towards the much anticipated recovery. However, a lot is dependent on consumers unleashing the accumulated spending over the coming year. Most of the additional savings have been from high-income households who have a lower marginal propensity to consume, therefore a reluctancy to spend will impact the recovery.