UK ECONOMIC & REAL ESTATE BRIEFING
“The recovery seen in the labour market since the end of 2020 continues, with the labour market now clearly turning a corner. The employment rate increased to 74.8%, the unemployment rate fell to 4.8% and the number of job vacancies are back above pre-pandemic levels.”
Sukhdeep Dhillon, Senior Economist
Since the onset of the pandemic, employment growth has been on a downward trend, with unemployment increasing. However, the latest estimates show improvements. The employment rate increased to 74.8% and the unemployment rate fell by 0.2 percentage points to 4.8%. The number of job vacancies is back above pre-pandemic levels, with 862,000 job vacancies in April to June 2021 – 77,500 above pre-pandemic level.
Despite the recent uptick in hiring, the extent of labour shortages have not impacted wage growth as significantly as expected. Average total pay growth increased by 7.3% and regular pay growth (excluding bonuses) was 6.6% in Q2. Temporary factors, such as a fall in the number and proportion of lower-paid employee jobs and low base effects, have inflated headline growth figures. According to the ONS, the underlying average total pay growth after adjusting for the fall in the number of low paid jobs is realistically around 2.5%, while regular pay growth is around 3.0%.
Nonetheless, the current levels of wage growth in addition to pent-up demand and shortages of supply are fuelling inflationary pressures. However, it is worth noting that in the middle of June 6.0% of the workforce was still on the Job Retention Scheme (JRS). As the JRS is phased out, this will cause upward pressure on unemployment. Reassuringly data from the HMRC indicates around 50% of those on the JRS are now partially furloughed, which suggests they still have a job to return to.
UK inflation continues to surprise on the upside, with the y/y rate increasing from 2.1% to 2.5% in June. Core inflation increased to 2.3%, and the RPI rate increased to 3.9%. The upside to inflation recently has been largely driven by core inflation, with the increase of 0.5% m/m representing the strongest June since records began. The high inflation rate has also impacted construction costs, which have risen by 10.2% y/y in May. The record increase in construction activity in June has led to a lack of materials which is likely to push up prices further.
The debate surrounding whether the factors causing inflation will turn out to be temporary or persistent continues across both sides of the Atlantic. The supply and demand imbalances are expected to narrow as UK continues ahead with its return to normality, but persistent factors will remain, which is why inflation will continue to remain above target until the end of 2022.
The recovery in UK real estate investment activity continues. Following the £12.6bn investment volume recorded in Q2, volume for H1 2021 reached £24.0bn. This is a 14% increase on H1 2020, and 12% above the volume recorded at the half-year point in 2019. Investment from overseas buyers grew 12% y/y. This signifies an encouraging return to pre-COVID-19 levels and demonstrates UK real estate's continued attractiveness to international investors.
Cyclical factors relating to the gradual easing of lockdown restrictions and the return to economic growth is helping to restore confidence in the office and retail sectors. For example, the retail warehousing sector, buoyed by resilient footfall data, enjoyed its busiest Q2 since 2016, recording over £800m of volume. UK office activity in Q2 grew three-fold on the historic lows of Q2 last year to reach £4.1bn, bringing the H1 total to £6.4bn - up 12% y/y. 36% of this volume is attributed to North American buyers, with Canadian investment giant Brookfield accounting for over £1.3bn alone thanks to their £714m acquisition of the Arlington office park portfolio from TPG.
Central London, however, continues to be relatively subdued. Volume recovered 92% on a y/y basis last quarter, taking 2021 to-date to £4.4bn, but this is down 21% on H1 2020, and almost half the long-term H1 average (-45%). Deal count for H1 was the lowest on record, but there was an encouragingly high volume of £200m+ deals at c. £2.0bn, the highest since 2018, helping to push the average lot size to its highest level for five years.
At the same time, prime yields are hardening. The combined effects of the pandemic and a global flight to an already-short supply of Grade A space with secure income streams is narrowing the definition of core and increasing weight of capital. With more prime transaction evidence emerging as confidence gradually returns, our prime office yields for the West End and City have moved in by 25 bps to 3.25% and 3.75% respectively - the first inward movement since 2016. Even so, London values are still at a 50-75 bps discount to Paris, Berlin and Frankfurt. Combined with a building pipeline of investment availability, this should help the Central London investment market recover strongly in H2 to reach £15.0bn at year-end.
Q1 2021 should mark the end to lockdown-induced economic slumps, with Q2 growth expected at 5.7%. The UK economy is expected to grow by 7.8% this year, outpacing other advanced economies, including the US (6.9%).
“£24.0bn of investment volume was recorded in the first six months of 2021, a 14% increase on 2020. Encouragingly, capital deployment from overseas buyers rose 13%, thanks partly from strong demand from North America-based buyers targeting offices and logistics.“
Charlie Tattersall, Senior Research Analyst
Looking ahead, cyclical economic momentum will continue to build as COVID-19 restrictions end, helping to improve investor risk appetite. Indeed, investor survey data suggests that real estate, viewed as an inflation hedge, will be one of the sectors to benefit the most from the economic recovery. Moreover, the gradual easing of travel restrictions will boost global capital flows, which will help improve liquidity further as we approach the e
“We are now at a significant turning point. The labour market, typically a lagging indicator, is showing continuing signs of recovery as economic momentum gathers pace. Business and consumer sentiment is improving, and UK GDP is now confidently expected to outperform most advanced economies including the US. This is providing a significant boost to investor appetite, which is why we expect investment volumes will return to pre-pandemic levels this year.
"Of course, there remain downside risks. For example, the extended eviction moratorium and the ending of Business Rates support will weigh on the recovery in the Retail and Leisure sectors. However, this will be at least partly offset by increasing footfall and consumer spending in our urban centres, and the 61% uptick in retail investment in the first half of this year provides further evidence of shifting investor sentiment in this sector. Meanwhile, significant amounts of international capital, particularly from the US and Canada, remains lined up to invest in UK offices and logistics.
"I am therefore confident that UK real estate is well-placed to benefit as we continue to transition towards a post-Brexit, post-pandemic economy."
Etienne Prongué, Chief Executive Officer