Source: Savills Research
Yields on hold for now, with downward pressure
No yield change
■ For UK prime yields, the most notable event in June was that there was no movement in any sector, despite the additional uncertainty created by the General Election. This was the third month in a row where yields have not moved in any direction. This increased level of uncertainty has stalled average prime yields at 4.7%, which are 70 basis points below the 10-year average of 5.4% (see Table 1).
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TABLE 1Prime yields
■ The UK investment volume for H1 2017 was £27.2 billion, which is 1% higher than the same period in 2016; London accounted for 50%. In terms of property sub-sectors, 39% of total investment in H1 has been for offices.
■ Some of the UK sub-markets, particularly the retail sectors, are restricted by the availability of stock, which has constrained volumes. There remains a healthy appetite for industrial stock to buy in to the structural shift in the retail sector. The last five years (2012/16) saw industrial account for 10% of total annual volumes; 2017 has seen a 14% share and hence, for multi-let, yields lower than a year ago.
■ Graph 1 presents an update of the prime versus average yields in the UK. The Brexit 'bump' is clearly defined, but the prime market average is yet to fall back to pre-EU referendum levels. The downward trends arrows on current yields suggest that we will continue to see a slight hardening despite economic and political uncertainty and the prospect of rising gilt yields. The differential between prime and average is close to the 180 basis point 10-year average.
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GRAPH 1Following the Brexit 'bump', yields have settled slightly higher than before the EU referendum
Source: Savills Research, MSCI
■ This month, we read with interest, that a major US pension fund is looking at "build-to-core" strategy. So called transitional assets are expected to become core over time with physical improvement or through new leasing. This shows the willingness for some funds to move along the risk curve to access stock and this may see the prime average differential close in the short-term.
Watching inflation
■ The normalising of monetary policy, i.e. putting rates up across many economies, is understandably an anxious move for any central bank to consider. The latest decision by the Bank of England was to keep rates on hold at 0.25%, but this was a decision by the eight Monetary Policy Committee members of five to three.
■ Annual inflation for the UK is 2.6%, which is well above the 2.0% bank target rate. Despite this, the level of disposable income has hit a low, with the lowest savings ratio on record – current estimate is 1.7% versus a 54 year average of 9.2%. Household finances remain under pressure and weaker Sterling continues to exacerbate the impact of inflation being imported to the UK economy through food prices, which have risen at the fastest rate for three years. Conversely, petrol prices helped inflation to fall in June.
■ Overall, the UK economy offers a mix of sentiment and data that has seen a widening of views as to the next rise in base rates. The majority of economists see no change for the remainder of 2017 and the Governor implied that now is not the time to raise rates despite higher inflation and the "froth" seen in some of the global equity markets.
■ Influenced by base rates, Graph 2 shows a consensus of opinion, from economists, of the expected trajectory for 10-year gilts in the UK. Compared to previous forecasts, economists currently expect a lower but still rising yield in the short-term. Overall, UK property will remain attractive to investors, particularly to overseas investors making use of moderate levels of debt to take returns to c.10%.
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GRAPH 2The latest expectation is for rising gilt yields in the next 18 months
Source: Focus Economics
One month and year on
■ One month after the snap election, and a year as Prime Minister for Theresa May, it is worth reflecting on the impact on the UK property market. As discussed on the front page, there has been no impact on the prime yields in the UK and the relative security of commercial property remains, despite lower return expectations.
■ Graph 3 shows that May has seen a positive 5% total return outcome over the year, which shows, despite Brexit, the market views the UK more positively than when Brown and Major inherited a much weaker UK economy.
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GRAPH 3May's first year has seen a recovery in UK total return performance
Source: Savills Research, MSCI
■ Total returns are expected to be around 5.5% for UK commercial property in 2017 and improve throughout the next five years. The RealFor predictions show that total returns should average 6.5% per annum, with the industrial market outperforming at around the 8% level.
■ Whilst the forecasts are predicting a lower return environment across the spectrum of investment sectors, uncertainties from the various worldwide political changes may create some localised volatility, particularly as the reality of Brexit negotiations become more apparent. However, the higher income returns from property look set to maintain its attraction from a wide pool of investor.