FULL REPORT
Latest statistics from the ONS reveal UK GDP fell by 2% q-on-q in the first quarter of this year. Despite the fall, these numbers have fared better than expectations and in comparison to other countries. Eurozone GDP fell by 3.8% q-o-q predominately led by French GDP falling by 5.8%. The Bank of England (BoE) was anticipating a fall of 3.0% q-o-q. It is worth noting the UK did not enter full lockdown until 23 March, so the first quarter numbers only reflect a week of full lockdown. Further details of the first quarter data reveal services output fell by a record 1.9% and production output fell by 2.1% largely driven by a contraction in the manufacturing sector.
contraction in the manufacturing sector. Construction output also fell (-2.6%). As the economy gradually reopens the construction sector is likely to face a slow return to previous levels as supply chains in many cases have been decimated. As a result construction output could fall by approx 25% this year. One positive flurry within the services sector is that a handful of services such as computer programming showed signs of growth. The COVID-19 fuelled lockdowns has led to growth in the use of platforms and services to keep businesses and households connected.
The BoE released their economic scenario in early May based on a set of assumptions. The BoE anticipate a fall of 25% in Q2 with full year GDP expected to fall by 14% in 2020 - the sharpest annual downturn since 1706. The scenario encompasses a substantial increase in unemployment. The BoE do believe the fall in activity will be temporary and GDP will recovery rapidly as social distancing measures are relaxed. A number of forecasters have revised their outlooks for the year as the assumption was for the UK to be back to normality by the end of the second quarter, this did not happen.
The changes to lockdown measures announced by PM Johnson on 13th May are relatively minimal, but there does seem to be a noticeable flurry of activity since then with commuters back on tubes, trains and buses. This could suggest UK activity could start to rise gradually, albeit still only by a fraction of existing capacity. The recovery will be dependent on how successful Government and Central Bank measures have been. However a number of downsides risks remain. The first, Brexit with an end to the post-Brexit transition period at the end of this year and a potential second wave of the virus.
The investment market remains on hiatus, with very little transaction activity. Volumes are hard to gauge accurately until quarter-end, but Property Data has tracked just under £4bn of volume since the start of lockdown (much of which will have been under offer pre-COVID). This is a 54% drop on the same period last year. With the June quarter rent collection likely to prove very painful, most landlords are now focused on rent collection and ensuring debt can still be serviced. As a result, the market is in price discovery mode, and those investors that remain active are expecting price discounts.
Investors are flocking to safety, but also searching for yield, meaning there is still strong demand for real estate's defensive qualities. Levels of dry powder targeted at global real estate remain high, and an increasing number of investors are launching distressed debt funds in anticipation for a wave for forced sales. The problem is that few unforced landlords are willing to sell until pricing solidifies, and with occupation demand suppressed and the June quarter rent likely to prove too much for many businesses, the turmoil is likely to persist for some time.
Investors are responding to the stalemate by making strategic plays for listed vehicles, taking advantage of their relative liquidity while shares trade at sharp discounts to asset value. Much of this is targeted at well-located, high-quality portfolios concentrated in sectors susceptible to the impacts of the crisis, such as London retail and flexible offices. In a sign of continued appetite from international investors, a well-known Hong Kong investor has just bought a stake in Land Securities. At British Land, GIC has increased their share holdings, while Brookfield has just taken a 7.3% stake.
Perhaps we should take comfort from this. In times of crisis, the inherent resilience of UK real estate will continue to attract global investors as record amounts of QE and low interest rates drive a hunt for value. We will see a shift in focus - long-let logistics and operational real estate will take more market share at the expense of secondary offices and retail - but the change will mostly be an acceleration of trends already at play, and there will be a renewed focus on fundamentals: income and covenant risk. As such, strong demand for space in core business and tech hubs such as London will remain.