FULL REPORT
Despite the upgrade, Q3 growth is still expected to ease. The Bank of England (BoE) is unlikely to make any decision regarding any rate rise solely based on GDP, and are instead more interested in the labour market. Latest jobs figures reveal the unemployment rate fell to 4.5% in the three months to August, down from 4.6% in July. Employment levels are now 1.8% below pre-pandemic levels, while the number of vacancies in September was up 30% compared to pre-pandemic levels. We still anticipate an uptick in the unemployment rate in Q4 as the furlough scheme has ended. However, there may well be a lagged effect as those that have come off the scheme may not immediately register themselves as unemployed or begin looking for a job. Although markets anticipate the BoE to raise rates much earlier than expected (December 2021), the BoE will want to ensure they do not make any decisions hastily, particularly as growth is easing, and the risk that consumer confidence may begin to falter. According to the GfK, the consumer confidence index fell four points to -17 in October. This may have something to do with the evolving COVID-19 situation, with cases up 19% week-on-week as of 21 October.
The BoE will want to examine the outlook for inflation over the next 2-3 years whilst overlooking current inflation. Therefore it seems prudent for the BoE to wait until February 2021, when they have a much clearer idea of what the impact of the ending of the furlough scheme has had on the labour market.
It was encouraging to see the Chancellor use better than expected economic projections from the Office for Budget Responsibility (OBR) to deliver a relatively generous budget. However, despite the upgrades to growth, the near-term forecasts show growth easing much more than the BoE. The OBR citied supply bottlenecks, withdrawal of fiscal support and a rise in COVID-19 cases impacting growth. The OBR also expect a rise in unemployment, reaching 5.25% by the end of this year. BNP Paribas believe the recent Budget has marginally increased the chances of a rate hike this year as the OBR have doubled their forecast for inflation in 2022, and do not expect inflation to return to target at least until 2024.
Overall, the measures announced in the Budget are positive for the economy, with the OBR estimating a 0.4% boost to economic growth in 2022-23. One thing that has not changed is the ongoing fiscal tightening; despite the change in pace it is still likely to have an adverse impact on economic growth. Looking ahead, labour shortages and supply bottlenecks will hold back growth and raise prices. Inflation could surpass 4% next year, the highest we have seen for ten years.
UK real estate investment activity continued its return to pre-pandemic levels in Q3. Transaction volume reached £12.4bn, 38% up on Q3 last year. This brought year-to-date volume to £40bn, 32% above the same period last year, up 11% on 2019 and up 4% on the same period in 2016. Central London investment has also been strong, recovering 40% y/y to reach £3.3bn in Q3 due to a continued flight to quality and a three-fold increase in capital deployment from European investors.
The UK-wide recovery in activity continues to be driven by rampant demand for logistics assets, where a chronic shortage of supply (down 40% since the start of the year and now at record-low levels) is driving strong rental growth. Volume in this sector this year to date stood at £11.5bn at the end of Q3. This is already the strongest year on record and 68% above the 10-year annual average. The sector has now accounted for 29% of all UK real estate investment activity by value in 2021 so far - the highest market share on record – and has helped to propel investment outside Central London to £31.5bn this year, up 43% on Q1-3 2020.
Activity has also picked up in the retail sector, with retail warehousing volume reaching £2.1bn by the end of September, representing the busiest Q1-3 since 2015. There have been some notable prime high street transactions, such as AL Khashlok Group’s acquisition of 50 Bond Street from Oxford Properties and Richemont for £228m (a 3.25% yield) and IKEA’s purchase of the former Topshop store on Oxford Street for £378m last month.
Following years of negative rental and capital growth, retail values are now at an attractive level for more investors to begin pivoting back to the sector. Indeed, MSCI data suggests rental and capital growth reached a floor earlier this year and their retail rolling annual total return benchmark reached 7.7% in September, the highest for three years and comfortably ahead of the 2.2% recorded for offices.
All signs are positive for a strong Q4, which should see the UK reclaim its former position as the number one commercial real estate investment market in Europe by year-end.
The recovery continues, but there are serious issues for investors to tackle. The impact of higher inflation is in full focus, but demand for hedging strategies will ultimately help sustain core real estate values. However, with COP26 now in full swing, all eyes are on sustainability and Net Zero. New European regulations come into force next year, while landlords are waking up to the requirement for all non-domestic buildings to have an EPC rating of B or above by 2030. With the vast majority of London’s office stock currently rated C or below, decarbonising capex costs will be a risk for the long-term.