FULL REPORT
UK GDP growth came in slightly lower than anticipated in Q2. Latest figures reveal the UK economy grew by 4.8% q-o-q, compared with the expected growth of 5.7%. In comparison to its peers, the UK enjoyed the strongest second quarter growth by far (France’s economy grew by 0.9%, Germany 1.5% and the US 1.6%.), partly due to the difference in easing of restrictions in the first half of this year. However, the US has recuperated all losses in output in Q2, while Eurozone output is 3.0% below pre-pandemic levels. The current level of GDP means the UK economy is still 4.4% below pre-pandemic levels.
Further breakdown of the figures reveals services, production and construction output increased over the quarter. The largest contributor to growth was from the wholesale and retail trade, accommodation and food service activities, and education sectors. Despite the widening of supply constraints and the ‘pingdemic’ crippling a large chunk of the workforce we still expect GDP growth to remain on track to achieve 7.8% this year.
The recovery is strengthening, with many aspects of the economy returning to, if not well above, pre-pandemic levels, in particular retail sales, the housing market and the labour market. Consumer spending was strong in Q2, growing by 7.3% q-o-q. This suggests households are unleashing the GBP200bn accumulated excess savings as expected. Conversely, investment remains lower than its pre-pandemic level. Business investment increased by a moderate 2.4% q-o-q in Q2. Although over 2% growth in business investment is positive, y-on-y comparison paints a dire picture where business investment increased by 0.9% while household consumption grew by 20%. The lack of recovery in business investment may in fact be due to supply constraints as well as the impact of Brexit.
UK inflation surprised to the downside with the rate falling from 2.5% to 2.0% y-o-y in July. This was largely driven by the fall in the core rate, which fell from 2.3% to 1.8% y-o-y. The largest downward contributions to inflation were clothing and recreation goods, partly reflecting base effects as July last year was particularly strong after the first lockdown. The July figures reflect a ‘normal’ level of inflation, particularly as the fall in restaurant price inflation points to the reopening effect waning.
Despite the lower than expected growth in the second quarter, growth remains on track for this year. There are likely to be revisions to growth, particularly in the final quarter when the economy should be back at full capacity. However, there are headwinds towards the end of the year that could impact growth. These include withdrawal of government support, widening of supply constraints and a potential winter wave of COVID-19.
Yield compression is now in full swing across the UK real estate market. Nowhere is this more evident than the logistics sector. The latest MSCI quarterly index shows average industrial net initial yields are now at 3.9%, dipping below 4% for the first time on record. The sector is on track for another very strong year, with volume this year to date already on par with the volume recorded for the whole of 2020. The sector has accounted for 30% of total UK volume so far this year, far surpassing the record 22% market share recorded last year.
Momentum also continues to build in Central London. Our proprietary investment data currently shows almost £8bn of office assets are currently for sale or under offer across Central London. Approximately £6.5bn of Central London offices have transacted so far this year, with almost £3.5bn changing hands in Q2 alone, in line with the 5-yr Q2 average. This suggests the Central London market is on course to outperform 2020 and reach our forecast of £15bn total volume by the end of the year.
Evidence of hardening prime office yields continues to emerge. Derwent London’s recent acquisition of 250 Euston Road (let to University College Hospital until 2039 with fixed 2.5% annual increases) from Lazari reflects a net initial yield of 2.5%, while Great Portland Estates is reportedly considering a sale of 50 Finsbury Square. The freehold block, which is set to be GPE’s first development to be certified as net zero, is expected to be worth around £215m, reflecting a yield of 3.75%.
Moreover, the growing prominence of the UK’s life sciences sector is beginning to narrow the gap between London and Regional office yields. Cambridge is a particularly focal point. Following Brockton Everlast’s purchase of five buildings at Cambridge Science Park earlier this year for a sub-4.5% yield, British Land made its first Life Science purchases last month, one of which was LaSalle’s Peterhouse Technology Park. The c. £75m deal represented a yield in the region of 4.15%.
This post-pandemic rebound bodes well for a return to the average annual investment volume levels next year, but going forward all eyes are fixed on the potential tightening of monetary policy next year in response to higher inflation.
Rising inflation in itself is indicative of strong GDP growth and is a generally beneficiary for commercial property. That said, the recent hawkish rhetoric from the Bank of England regarding tapering of bond purchases suggests we should be mindful of the risk of tightening monetary policy earlier than anticipated. The ensuing impact on bond yields, financing costs and asset prices should be watched closely.