FULL REPORT
The first estimate for Q3 reveal the UK economy grew by 15.5% q-o-q, the largest quarterly increase since records began in 1955. The latest figures mean, of the 25% of output that was lost in Q2 due the first lockdown, the economy has now recovered about two thirds. As is stands the UK is still approximately 10% below the levels of the end of 2019. This is similar to other countries such as the US, Germany, France, Italy and Spain all of which have experienced record increases in Q3 but their output still remains below where it was before COVID-19.
Analysing the cumulative performance across the three quarters of the year so far shows that the UK witnessed a much larger decline in output, twice as large in fact compared to Italy, Germany and France. This partly reflects the structural features of the UK economy that have been much more exposed to the restrictions imposed.
A bounce back in all sectors was expected as soon as lockdown measures were eased. Output across the services and manufacturing sectors increased by record levels. Services output increased by 14.2%, production output by 14.3% and
and the construction sector witnessed growth of 41.7%. The increase in the services output was largely attributable to the 30.7% growth in the wholesale and retail trade sector which recovered all lost output, even exceeding the levels see in Q4 2019. The hospitality sector also made a significant contribution to growth, largely due to the 'Eat Out to Help Out' scheme and the increased number of 'staycations' that has helped the domestic hotel sector.
The Bank of England (BoE) have revised their forecast for the UK economy at the latest MPC meeting
meeting. The BoE have downgraded forecast for this year and next. UK GDP growth is now expected to decline by 11% in 2020 (downgrade from -9.5% in Aug) and growth of 7.25% in 2021 (from 9% in Aug). They have stated that the outlook remains highly uncertain. The latest forecasts are based on the assumption that COVID-19 restrictions that were in enforced in mid-Oct remain in place somewhat until the rest of Q4 and Q1 2021, as a result this will weigh on activity in the near term. BNP Paribas have also revised their forecast with UK GDP growth expected to be -11.5% in 2020, and 6.4% in 2021.
The latest lockdown has halted the economic recovery, creating challenges for the UK real estate market. Central London office take-up reached just 900,000 sq ft in Q3, down 72% y-o-y. Tenant-led available space, a key indicator of market health, currently sits at c. 3.9m sq ft, up 125% since January.
With many occupiers rethinking requirements, we are now seeing early signs of a downward correction as supply increases. Our forecasts for 2020 prime rental growth in the London City and West End are -3.8% and -9.5% respectively.
The expectations are for capital values to follow suit. Indeed, London office REITs are currently trading at significant discounts to NAV; Derwent was trading at a 17% discount as of last Friday, with GPE at 23%. However, there remains a curious disconnect between the leasing and investment markets, with valuers waiting for more comparable evidence. MSCI’s latest monthly results show Central London office capital growth down only 2.1% over the previous six months. A big correction may be inevitable, but the immediate outlook isn’t as bleak as many believe.
Gilt yields remain low - 5-year bonds are hovering around zero - and corporate bond yields to maturity are sub-2.0%. Investors are being forced to consider alternatives such as real estate, even if income returns have dropped. Liquidity in core markets is improving as a result, with £2.8bn under offer in the City alone, but with supply still relatively low we are starting to see yield compression. Brookfield’s £472m disposal of 1 London Wall Place last month, at 3.8%, suggests prime yields have dipped below 4.0%, while WR Berkley's recent launch of The Scalpel at 3.5% (£820m) will test the market further.
This clearly increases the focus on rental collection, which has been incredibly challenging and not helped by the current moratorium on forfeitures. This helps explain the focus of investor capital around reliable income plays such as core offices, logistics and BTR, but the lockdown will undoubtedly impact rent collection further. While easing monetary policy and the economic outlook will keep bond yields low and encourage increased real estate allocations for now, it remains to be seen how much this will offset the pricing correction when valuations catch up with falling rents.