Publication

Market in Minutes: UK Commercial

Upward yield pressure intensifies




The talk of recession and the rising cost of debt exerted more of an influence on investor sentiment in July than it had done in June. Five sectors reported outward yield shifts of 25 basis points (bps), up on the three in June, bringing Savills average prime yield to 4.88%. Likewise, the number of sectors reporting upward pressure also increased from three to eight.

Those sectors most exposed to the consumer spend squeeze, and the rising cost of debt, are at the brunt of the current softening. For example, both retail warehouse sectors open A1 and restricted) and foodstores saw yields move out in July. For these sectors, prime yields average 4.83%, whereas high street retail and shopping centres, which reported no outward shifts, have prime yields some 192 bps higher at 6.75%. Similarly, logistics and industrial, which have some of the keenest yields in UK real estate, saw yields soften by 25 bps.

Following the first increases in debt costs just before the summer, many investors opted to pause their acquisition programmes. However, feedback is that most of this capital is still available to be deployed, albeit at softer pricing, and no doubt some will want to see that prices have stabilised before further investment.



What could a recession mean for capital values?

The Bank of England produced a surprisingly pessimistic outlook for the UK economy in its latest monetary policy report. It projected that the UK would enter recession in Q4, with output forecast to fall in each subsequent quarter through to Q4 2023. Whether this materialises remains to be seen, with other forecasters suggesting that economic growth will slow but will avoid recession. For example, Oxford Economics forecasts that 2023 GDP will slow to 0.8% in real terms.

Whether we experience a recession or an economic slowdown, there will be an impact on capital values. But, can history provide some insight to the degree of this impact?

Cautious optimism is starting to materialise for the inflation outlook, as the inventory overhang and waning consumer demand could potentially mean a faster-than-expected slowdown in inflation

Marie Hickey, Director, Commercial Research

During the 2008/09 (GFC) recession, All Property capital values fell 42.0% peak to trough over nine quarters. The Covid-19 downturn saw values fall 9.1%. A repeat of either of these in 2023 is highly unlikely as we do not have the same liquidity challenges we had in 2008/09 and hopefully not the same global shutdown as in 2020.

A 2011/12 scenario looks more representative. This was a period where UK GDP slowed on the back of eurozone uncertainty and questions over its survival. It also followed a post-GFC bounce both in terms of economic growth and capital values – similar to what we have seen over the last 12 months. Back in 2011/12 we saw four quarters of slowing value growth followed by five quarters of decline. However, in peak to trough terms, All Property values fell 3.0%. But, this is very much an average, and given what we have already seen in price adjustments to date, there is likely to be significant variations between sectors and regions.

What happens to capital values over the second half of this year and into 2023 will be dictated by what happens to inflation and its read-through to the economy. Cautious optimism is starting to materialise for the inflation outlook, as the inventory overhang and waning consumer demand could potentially mean a faster-than-expected slowdown in inflation. This could reduce the risk of recession and significant capital value declines. But, we will be watching lead indicators closely over the coming months.


 

Leisure-spend trends

The ONS is looking to experimental data sets to provide real-time insights into consumer spending. One of these is using daily card spending data from financial technology company Revolut. Daily data for July and early August points to an upward trend in leisure-related spend in the face of rising inflation, led by travel and accommodation spend, which is unsurprising considering the start of the summer holidays. In contrast, retail spend has declined to date in August. This trend may reflect the younger and more metropolitan demographic of the Revolut customer, whose current confidence and spend is more resilient to the cost of living squeeze and the fact that this group tends to prioritise leisure-related spend. As seen historically, leisure spend and, in turn, occupational and investment demand, has shown a degree of recessionary resilience. Albeit, this resilience may soften as we move into Q4.