Economic and Market Commentary – Q3 2019

By November 9, 2019News

Brexit news

The Westminster soap opera continues. Having been forced to eat humble pie and reluctantly agreed to send a request to the EU to delay, again, the proposed date of Brexit, Prime Minister Johnson countered by demanding a general election, which opposition parties agreed to once the threat of a ‘no deal’ Brexit was apparently off the table. Whether another election will actually solve anything is unclear, as early opinion polls indicate that it is unlikely that any party would command a majority.  Westminster could be just as split after the election as before.

Meanwhile, the Bank of England through its governor Mark Carney, reported that the deal crafted by Johnson had created “the prospects for a pick-up in UK growth”, adding that the annual rate of GDP growth would rise from around 1% at the end of this year to more than 2% by the end of 2022 – low by historic comparison but in line with its European neighbours. This growth spurt would be helped by a “world that had stopped weakening and is picking up a little bit” plus better news for the consumer through the reduction in uncertainty.

However, the Bank’s Monetary Policy Report did acknowledge that a weaker global economy and its new assumptions about Brexit would knock a cumulative 1% off UK growth over the next three years compared with its forecast three months ago.

Global economy

Over the past year, the rate of global growth has fallen sharply. The slowdown has been noticeable not only in the advanced economies but in emerging markets. The weakening has been broad based, affecting major economies (particularly the United States and the euro area) but also smaller Asian advanced economies. The slowdown in activity has been even more pronounced across emerging markets and developing economies, including Brazil, China, India, Mexico, and Russia, as well as a few economies suffering macroeconomic and financial stress.

Manufacturing has been the cause of much of the recent weakness in global growth, not unsurprising given the increase in trade and geopolitical tensions. Not only has this downturn taken its toll on global trade but it has also negatively impacted business confidence and investment intentions.

Counteracting this has been moves by the central banks to increase monetary accommodation – most notably the decision to cut interest rates in the US and in the eurozone and the reintroduction of the eurozone’s programme of quantitative easing. The continuing weakness in global activity has caused our growth forecast for 2019 to be cut from last year’s already underwhelming 3.6% to 3.0% – the lowest since the global financial crash – although we do expect a bounce to 3.4% next year, 10 basis points lower than our expectation three months ago.

Risks to these forecasts remain skewed to the downside and have increased over the summer months. Continued escalation of trade tensions coupled with increased policy uncertainty could well further damage investor and business sentiment which in turn could well bring about a deterioration in financial market sentiment.

The EU economy

The outlook for the eurozone has deteriorated over the summer months.  Expectations for this year have now fallen to a mere 1.2%, 20 basis points lower than our previous forecast and 40 bps lower than expectations at the beginning of the year.  But even that rate is questionable following another dull quarter for growth.

The recent weak data in Q2 and Q3 highlight just why the ECB has been forced to redeploy fiscal measures in order to try to kick start the economy. After posting GDP growth of 0.2% in Q2, the third quarter recorded an identical rate for the euro-area, implying that growth over the last 12 months has fallen to only 1.1%, not much greater than that of the UK.

Germany, which has borne the brunt of the eurozone’s economic slowdown owing to its export oriented focus and reliance on the automotive industry, at least avoided recession. Its second quarter growth rate was downgraded by 10 bps to -0.3% but in the most recent quarter, it posted a small, but significant, growth of 0.1%. Nevertheless, forecast growth rates for the single bloc’s largest economy of 0.5% this year and 1.2% next highlight how dependent Germany is on exports and the car industry. However, manufacturing data picked up towards the end of the quarter while trade figures were solid in September. Our forecasts for Germany have been cut by 20 bps to 0.5% and by 50 bps to 1.2% for next.

Early data from other countries indicate steady, if unspectacular, rates of growth. France, Spain and Italy recorded similar rates of growth in Q3 compared to Q2 at 0.3%, 0.4% and 0.1% respectively.  The dull overall outlook for trade has prompted minor, 10 bps, reductions in our expectation for growth in 2019 in each of these countries.

The UK economy

In a year of seemingly relentless gloom for the economy, news that the UK avoided entering a technical recession can only be regarded as good news. After the weak second quarter which saw the economy contracting – itself a reaction from the unwinding of the stockbuilding ahead of the original date of Brexit – Q3 posted growth of 0.3%.  Despite the favourable outcome for Q3, the economy is on course for its weakest performance since the financial crash with growth now estimated at little more than 1.0%.

Once again, it was consumer spending that led the way in the third quarter, rising 0.4% and helped by above inflation wage increases. Business investment was flat, which was a relief after several quarters of constant contraction while there was, surprisingly, a positive contribution from net trade. Manufacturing output was flat in the quarter, as falls in many industries were offset by increased car production. Stockpiling, which was a feature of the period surrounding the original date of Brexit, was much less evident in Q3, although it may still be present in the October statistics.

All in all, data for 2019 so far indicates a ‘stop-start’ economy with growth punctuated by the various Brexit deadlines and with little likely to alter in the coming months until the Brexit conundrum is settled once and for all.

Growth in Q3 was skewed to the first half of the quarter when July posted strong levels of activity. In contrast, monthly indicators point to the economy contracting in August and September.  Whether that poor momentum is carried on into the fourth quarter, or whether the October Brexit deadline will indeed bring about another mini boost to the economy will be revealed in the coming weeks.

Meanwhile, in the world of retailing, October footfall statistics continue to paint worrying trends. A year on year fall in footfall of 3.2% was blamed on the wet weather. The high street fared even worse, seeing a year on year decline of 4.9%.

There is a high degree of risk surrounding the UK economic forecasts,  Not content with global trade tensions and Brexit uncertainties, we now have a general election whose outcome is just as difficult to predict.  It could usher in perhaps the most defining period of government since the outbreak of the Second World War.

Market Commentary

Average commercial property capital values dipped in Q3, falling 0.8%, and bringing the cumulative fall over the last 12 months to 2.5%. Once again the fall was accounted for by the retail sector, down another 2.9% on average in the quarter for a 12 month decline of 10%. By contrast, average industrial values kept on rising, up another 0.5% for a 12 month rise of 4% while offices marked time, up less than 0.1% in the quarter and 0.6% in 12 months.

We have written at length about the challenges facing the retail industry in general and high street outlets in particular. There seems no end to the misery facing retail investors with shopping centres and retail warehouses both losing 4% in value over Q3 for a 12 month decline of 15% and 13% respectively.

While these weaker performance numbers are not surprising given the economic and political backdrop, they remain relatively resilient. Since the EU referendum in June 2016, the UK commercial property market has held up significantly better than most had anticipated in the immediate aftermath of the referendum. After a ‘kneejerk’ 3% average fall in property values in the quarter immediately following the referendum, average property values have subsequently risen by 6.1%. That average statistic masks a wide variation in sector performance though: industrial values have risen a staggering 31% since September 2016 and offices are up almost 7%. Only in the retail sector have average values tumbled (by 8%) but as discussed before, much of the fall can be attributed to the structural issues facing the retail sector and not simply by Brexit concerns.

The recent dull environment for capital growth has been matched by a significant slowdown in transaction levels. As mentioned in the last quarterly report, this slowdown is not just a feature of the UK commercial property market, but has been experienced in many other property markets.  Over the first nine months of the year, transactions in the UK have fallen by more than one-quarter compared to the same period last year. And while transaction levels by overseas investors in total have fallen by a similar amount (24%), those by US investors and Middle Eastern investors have risen by 56% and 15% respectively. Once again, a key reason for the lower transaction levels is lack of available product in the market: investors are unwilling to sell without having clear re-investment prospects.

Central London offices

As pointed out in our previous quarterly report, investment in central London offices has dropped significantly this year – a slowdown that has become evident not just in the main UK office markets, but in office markets around the globe. Brexit uncertainty, while a major distraction, has not been the only impediment for both domestic and overseas investors. As mentioned above, some investors are reluctant to take even strong profits when there are so few re-investment opportunities.

Investment turnover in the City of London office market, at £1.84bn in the third quarter, was barely half that recorded twelve months ago, making the total investment over the first three quarters of the year just £4.86bn, the lowest for eight years and almost 20% lower than the 10-year average. If anything, the equivalent figures for the West End are even more disappointing.  Q3 investment was less than £1bn bringing the total for the first nine months of the year to just £2.8bn, 42% less than last year.

Not only is there a dearth of stock available, it seems that some vendors are unwilling to complete a sale instruction even after terms have been agreed, reasoning that better market conditions in the future may deliver a higher selling price. Certainly, the ultra-low level of interest rates which look likely to last for some time yet, coupled with expectations of continuing strong tenant demand does seem to back that assertion.

Take up remained resilient in Central London. After last year’s exceptionally strong levels of tenant demand, take up in the City and West End office markets has slowed over the first nine months of the year, by 14% and 19% respectively, although both figures are in line with the 10-year levels.

Owing to the fact that relatively high level of development completions in Q1 2020 are now included in Q3 supply calculations, the City’s vacancy rate has jumped 70 bps from the June’s 5.0% to 5.7%. The large development nearing completion and now included in this statistic is the 770,000 sq ft, 62-storey office building in Bishopsgate, EC2, which is already 28% pre-let. The vacancy rate in the West End was steady at 4.0%, down 10 bps over the summer.  Developments are beginning to increase.  Over 25m sq ft is due to be completed in the two office markets over the four years 2020 – 2023 inclusive, of which 21% has already been pre-let.

Rental levels continue to edge higher in both markets, both at the prime end and at the average IPD-determination of rents in central London.  At the prime level, City rents hit an all time record high of £82.50 psf, while West End rents were 13% higher than those 12-month earlier, recording £120 psf.

Prime yields in the City and West End are unchanged over the quarter at 4% and 3.75% respectively.


Such has been the frenetic activity by WeWork in London over the last few years in accumulating space to rent, investors may now be questioning the company’s influence on both investment and lettings markets following the recent failed flotation and the announcement of its requirement for a cash injection from SoftBank, its largest shareholder.

At the end of September 2019, there is approximately 12m sq ft of vacant office space in central London (7.5m sq ft in the City and 4.5m sq ft in the West End), equating to vacancy rates of 5.7% and 4.0% respectively. These vacancy rates are low by historic standards, helped by still buoyant levels of take up and low levels of development.  Another way of looking at these supply / demand statistics is that the current levels of supply are equivalent to 13 months (City) and 12 months (WE) of take up at the current rate of take up. As a rule of thumb, it is generally accepted that the City and West End office markets are deemed to be oversupplied if supply exceeds 20 months at the current rate of take up. Hence by this measure, neither office market looks close to being oversupplied.

With questions surfacing about the sustainability of WeWork’s business model, what impact could a company failure have on the central London office market?  Over the last five years, WeWork has accumulated 2.7m sq ft of office space in the City and 1.1m sq ft in the West End. On a worst case scenario – ie if all this space is returned to the market and falls vacant – this excess space would increase the months’ supply to 18.5 months in the City and to 15 months in the West End – still below the 20% threshold. Of course, such a scenario is unlikely to pan out as other office providers would no doubt pick up at least some of the available office properties (and the tenants) for their own investment.

Hence, while a corporate failure of WeWork would undoubtedly have some repercussions on office markets globally, and would likely cause some temporary hiatus, the medium term impact on central London is likely to be relatively modest.

All investment and take up statistics from Savills, all performance statistics from MSCI.