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Economic and Market Commentary Q2 2021

By | News

Brexit news

June saw the signing of a trade deal with Australia, removing all tariffs on all goods, the first major trade deal negotiated from scratch by the government since leaving the EU. Last year, trade between the two countries amounted to £13.9bn and this figure is likely to increase following the agreement.

The Secretary of State, Liz Truss, claims that the agreement paves the way for the UK to apply to join the Trans Pacific Partnership, the 11 nation, £9 trillion free trade area which is home to some of the biggest consumer markets of today and tomorrow.

Predictably, the complex situation of Northern Ireland shows no sign of being resolved. The Northern Ireland protocol, signed by both the UK and the EU as part of the withdrawal agreement, prevents a hard border in the island of Ireland by keeping Northern Ireland in the EU single market for goods. Difficulties have arisen in transporting goods across the Irish Sea in terms of both bureaucracy and in raising prices, while the Unionists are concerned that the protocol undermines Northern Ireland’s place in Great Britain.

The House of Lords has ruled that both the UK and EU have taken a ‘fundamentally flawed’ approach to the protocol and that both sides need to compromise. Easily said, but whenever Northern Ireland is concerned, not so easy to do in practice.

In addition, there is also disagreement over the so-called ‘divorce bill’ – the amount the UK has to pay the EU for spending commitments made before the UK left the bloc. New figures from the EU puts the total at £40.8bn, significantly above the UK’s assertion of between £35bn and £39bn. The government insists that the EU has ignored money owed back to the UK.

No doubt these disagreements will rumble on. Where would we be without a little bit of tension between the parties!

Global economy

Eight months into the vaccination programmes, countries’ economic prospects are diverging further, depending on access to vaccines. On the optimistic side, developed countries can anticipate further normalisation later this year while those less able to obtain the vaccine access are still facing resurgent infections and still rising death tolls. Even those countries in this latter group where infections are currently low, are not assured of a quick recovery as long as the virus is circulating elsewhere.

The global economy is now forecast to grow 6.0% this year, unchanged over the last three months, masking a 50-basis point increase in the growth of the advanced economies and a 40 bp reduction in developing economies. Next year sees a 50 bp increase to the global growth forecast to 4.9%. This time, both advanced and developing economies have been upgraded, by 50 bps and 20 bps respectively, from our forecasts three months ago.

The advanced economies have been boosted by continued policy support and the expectation of additional fiscal support in the US later this year. Greater optimism from health metrics is also a factor in the upgrades.

Nevertheless, risks to these global forecasts remain tilted to the downside. The clearest danger is slower than anticipated roll out of the vaccine, particularly to developing markets. But there is an obvious risk that financial conditions, which have remained accommodative throughout the pandemic, may be reassessed, especially if inflation expectations increase further. That is a point we delve into at greater length in the next section. The twin hits of limited vaccinations and higher interest rates brought about by a tightening of monetary policy would be particularly bad news for both emerging markets and developing economies.

First quarter 2021 GDP outturns surprised on the upside, particularly in Asia and Latin America. Conversely, renewed lockdowns, from which countries are just now emerging, have hit European economies. However, data for Q2 has shown that the recovery, which began in manufacturing, is now widening into service sectors. Recovery, though, has been and still is being hampered by component and labour shortages and disruption to the supply chain, all of which are affecting the speed of the bounce bank and rates of inflation.

Flash estimates of activity in Q2 remain mixed. Annualised growth of the US economy fell short of consensus growth of 8.5%, recording 6.5%, while the eurozone posted quarterly growth of 2.0, ahead of some expectations. Japan has yet to publish its Q2 estimate but expectations are for growth of 0.2%, thereby halting the run of negative quarters of growth. Disappointing consumer spending figures continue to hold back the Japanese economy. While both the US and EU are seeing accelerating growth across many sectors, the rising number of patients infected with the ‘Delta’ variant is clearly reminding everyone that we are not out of the woods yet.









Concern has risen globally about the sharp rise in inflation and whether that will affect interest rates and through them, property yields. Inflation does tend to increase as economies start pulling out of recession and this time is no different, inflation having picked up in many economies. The reasons for this rise are both the cyclical recovery phase in which economies find themselves and the sharp reversal out of recession that we are experiencing.

In most recession/recovery phases, time frames can usually be measured in years: this time one of, if not, the severest downturn followed by a sharp recovery can be measured in just a few months. Supply bottlenecks have been adding to pricing concerns, while, arithmetically, commodity prices were at rock bottom twelve months ago, meaning that annual rates of price increases are abnormally high. The table below shows the price increases of selected commodities this year.



There are two key questions regarding inflation. The first is, is the rise temporary, implying that rates will quickly revert to more ‘normal’ levels? The second is, will central banks take action to prevent higher rates of inflation in the future by tightening policy before the economic recovery has fully taken root. That will invariably result in higher interest rates

We believe that inflation is in most cases likely to subside to pre-pandemic target levels next year and that central banks are unlikely to raise interest rates in the short term. Our view therefore remains that interest rates will remain low for some time yet. It could, however, be more persistent if people and businesses come to expect higher inflation and seek to raise prices and wages in anticipation. That has been recently illustrated by some supermarket chains in the UK who are offering a sizeable joining bonus to lorry drivers, who are in short supply.


The EU economy


As activity begins to return to some sort of normality, EU unemployment is falling The rate of unemployment fell from 7.4% in March to 7.1% in June, but it still means that 14.9 million people are out of work. A year ago, the rate of unemployment was 7.6%.

Our economic forecasts have been increased for both this year and next by 20 bps and 50 bps respectively. As with our forecasts for the other economies, the risks are skewed to the downside and are vulnerable to a renewed spread of the virus.


The UK economy

With many Covid restrictions being unwound across the UK, expectations are for the economy to deliver strong rates of growth this year. GDP for Q1 fell by 1.6%, but the economy has been on recovery mode since the end of January. The first estimate of growth in Q2 came in at 4.8%, slightly below some forecasts but we still believe that the UK is on track for a full year growth forecast of 7% (Source: IMF), an upgrade of 1.7 percentage points since our last report three months ago. Some forecasters are putting even stronger growth this year at nearer 8%, but even so, growth of 7% would be the highest yearly growth since the Second World War.

Our forecast for next year, 4.5%, is also below some forecasts, but trying to place precise estimates for events months in the future is fraught with difficulty particularly when we cannot rule out new or more virulent strains of the coronavirus affecting life for months to come.

Some caution is required before these forecasts are met:

  • Covid case numbers in the UK are still running at elevated levels and though, thanks to the successful vaccination programme, the direct link between case numbers and hospitalisations seems to have weakened, we cannot dismiss the possibility that the ‘Delta’ variant or some new strain emerges to stall economic activity.
  • The furlough scheme is winding down. It has been a resounding success in preventing major job losses over the last 17 months. It is telling that the unemployment rate, which many economists at the onset of the pandemic expected to rise towards 9%, is now likely to have peaked at 5.2%, an increase of just 1.3 percentage points from pre-pandemic times. However, some further job losses are anticipated from those now coming off furlough.
  • The ‘pingdemic’ effect whereby workers are required to self-isolate when they are identified as a close contact of someone infected. The number of persons required to self-isolate has been modified downwards, so hopefully, future such cases will lessen any hit to output.
  • Skills shortages. The economy has changed over the last 17 months, in some industries, out of all recognition. Clear winners have been food stores and online retailers. Losers include some high street retailers with no online presence and some hospitality ventures, some of which will struggle to survive even with lockdown restrictions being removed. This change in the structure of the economy is ongoing but is creating some pressure points. For example, shortages of lorry drivers have been highlighted by some supermarket chains but finding and training new staff is one thing; obtaining driving tests for these drivers is another with major delays in that process.
  • Supply chain bottlenecks are affecting all countries and many industries. We highlight one aspect that has directly impacted the commercial property landscape – the move from a ‘just in time’ stock control system to a ‘just in case’ one. It will be interesting to follow this in the future to see if the latter endures.

As well as unemployment starting to decline, job vacancies are back above levels pre-pandemic. The latest vacancies covering the three months April to June 2021 amount to 862,000, 10% above the last three-month period before the onset of the restrictions. These labour shortages are contributing to some increased wage pressure with average basic pay having risen by 6.2% in Q2. However, much of this apparent strong figure is due to temporary factors such as a fall in the proportion of lower paid employees. ONS believe that the underlying average pay growth after adjusting for the reduction in lower paid jobs is likely to be around 2.5% – 3%. This lower figure for underlying wage growth is one of the factors behind the Bank of England’s relatively benign view of the current rate of inflation.

The ongoing vaccination programming coupled with the relaxation of many of the restrictions has pushed consumer confidence back to a pandemic high. Confidence numbers declined to levels last seen in 2007 at the onset of the first Covid lockdown in March 2020 but since the turn of 2021, they have been on an upward trend. The latest, July, figure is now higher than it was immediately before the coronavirus took hold of the economy last March.



A separate survey by You Gov highlighted that the outlook for job security and confidence among households about their personal finances are both at record high levels.

That said, headline wage growth is picking up and coupled with pent up demand from both businesses and consumers, inflationary pressures are rising. Add in shortages of some raw materials and supply chain bottlenecks, inflation is on the increase. CPI inflation for the month of June measured 0.5%, the strongest monthly increase in June since records began, leading to the rate for the year to June increasing to 2.5%. The rate will increase further over the coming months to over 3% and it is likely to remain above the Bank of England’s 2% target this year and for most of next year.

From commercial property’s point of view, construction costs increased by over 10% for the year to May. Not only have raw materials been in short supply, so have workers as the industry struggles with record levels of construction activity. These cost pressures will certainly be affecting development opportunities in the commercial market with new distribution warehouses being the most at risk of being delayed, or cancelled altogether, at present.

The labour market is continuing to recover in line with the momentum behind the economic recovery. Further Covid shocks aside, the UK is poised to post the highest 2021 GDP growth rate of the G7 group of countries. Laudable as that may be, one must not lose sight of the fact that the UK posted the worst decline in activity of these countries last year.

As Covid-induced restrictions unwind, some businesses will feel the full brunt of the ending of the moratorium on eviction while the ending of business rates support may hamper some retail and leisure entities.


Market Commentary

Not only has the commercial property market been moving at different speeds, it has also been going in different directions – the gung-ho industrial market, the resilient performance of offices and the valuation collapse of many retail assets. Growth in asset values in the industrial market alone has propelled the market as a whole into positive territory for the last two quarters. Leaving the high-flying industrial sector to the side, the performance of the rest of the market has been less satisfactory, but more in line with returns expected during the more challenging recessionary influences that we have encountered.

There was a welcome return to growth in retail assets in Q2, growth in average shops and retail warehouses offsetting the continuing collapse of shopping centre valuations. This return to average asset value growth of retails ensured that all three main sectors posted positive growth in the quarter for the first time since the last quarter of 2018.

Growth in average property values, as measured by the MSCI Quarterly Index, came in at 2.3% for Q2, nicely building on the return to growth seen in Q1. But this return to growth has been flattered by the performance of the industrial sector, which in Q2 delivered average growth in values of 6.4%, the highest quarterly figure since the MSCI Quarterly Property Index was launched in 2001.

At least the cataclysmic fall in retail values has ended with Q2 growth of 0.3%, although that masks a diverging profile with retail warehouses seeing 2.0% growth in the quarter but shopping centres continuing its downward trajectory with a further fall in average valuations of 2.7%.  The move by retail assets as a whole into positive territory ended a run of ten quarters of declining capital values.

The performance of offices during the pandemic has held up remarkably well, capital value movements being midway between the soaring industrials and plunging retails. There is little consensus as to how the office will work in the future. It certainly will not be the same; but we do not subscribe to the theory that the office is dead with everyone working from home. Neither do we expect offices to return to pre-pandemic levels of occupancy. Yes, some firms will take one or the other of these extremes but the large majority will favour a ‘blended’ approach, workers mixing working from home and working in the office, with office capacity reduced.

From a performance point of view, there has never been such a wide spectrum of returns. In the five quarters since the onset of the pandemic (the beginning of Q2 2020), total returns from a basket of retail assets were -6.7%, a basket of office assets, 0.1% while industrials would have delivered an astonishing 22.6%. If one’s fund performance is measured and ranked by MSCI, sector allocation has never been more crucial.

So critical, that a fund with the foresight of not having any retail assets and whose sector allocation otherwise followed the MSCI Quarterly Index’s sector weights would have delivered a total return 6.25 percentage points more than the official All Property total return over these five quarters (10.6% v 4.35%) and four percentage points per annum more over the last five years (8.3% pa v 4.3% pa) (both author’s calculations).

Commercial property yields are currently showing no signs of following gilt yields higher. MSCI report continuing yield hardening in sectors over Q2 (when yield compression was the greatest contributor to capital growth for the market as a whole) while Savills report that prime yields have remained, on the whole, static over the quarter with West End offices falling another 25 basis points to 3.25%, a level last seen almost three years ago.

It is easy to see why the industrial market has been the clear winner in terms of performance recently. For investors, industrial, until recently, was regarded purely as an income play, its high yield compensating for minimal, if any, rental growth. How that has changed over the last year or so. Strong demand from investors has pushed average yields down to historic lows (and to levels considered unlikely just a few years ago). At the end of Q2, average (equivalent) yields of industrial assets in the MSCI Quarterly Index stood at 4.4% – the lowest of the three main sectors. Prime industrial yields, according to Savills, now stand at 3.5% – a year ago they were a full point higher.

Investors remain optimistic over the prospects for industrial assets. Take up is running at unprecedentedly high levels, vacancy rates are at historic lows while the development pipeline is struggling to keep pace with tenant demand. Online distribution facilities have mushroomed during the pandemic and ongoing disruption to global supply chains (not eased by Brexit issues) are forcing businesses to hold more stock than was thought necessary before – in effect changing the business model from ‘just in time’ to ‘just in case’.

Industrial space take up is running at its fastest pace ever, over 24m sq ft in the last six months, and over 50m sq ft in the last twelve months, both records by a long way. The bulk of recent transactions are from online retailers but manufacturers too are acquiring more units, its share of the warehouse take up doubling to 15% in the space of one year.

Investment volumes for the market as a whole are picking up. Deals worth £12.59bn in Q2 (source: Property Data and BNP Paribas RE) was the highest second quarter for three years. Likewise, the total for the first six months of the year was the highest since 2018. And though this half year total is comparable to the ten-year average, it is a pale shadow of the volume of transactions during the middle of the last decade. Indeed, the £23.95bn total transacted over H1 was just 60% of that in 2015 at the height of the market.


However, the source of capital for these transactions has been shifting over the decade. UK investors are still the largest single grouping by a long way, but their share of total UK transactions has fallen from 64% in 2011 to 48% last year while the domestic share during the first six months of 2021 has shrunk even further to 44%.

It is worthy of note that overseas investors do not seem to have been put off investing in the UK since the Brexit vote in 2016. Their share of total transactions has continued to rise despite the grave warnings that some economists made at the time of the referendum about the viability of UK business after it leaves the EU. Indeed, the year after the vote, 2017, saw the highest annual amount of UK property bought by overseas investors (£32.5bn out of that year’s total of £66.5bn). It’s wonderful what a sharp deterioration in the sterling exchange rate does to the mindset of overseas investors!

The sustained investors demand has ensured that total returns from commercial property remain highly competitive against other domestic asset classes. Indeed, over the last decade, commercial property has delivered higher returns than those of UK equities and government bonds. Also note the recent strong performance of REITs which is often a leading indicator of the performance of direct property.


Some commentators are suggesting that, in an era of higher inflation, commercial property is well placed as an inflation hedge. We do not fully subscribe to that view. The rental growth outlook remains particularly weak for retail and office assets, with only industrial assets generating meaningful rental growth over the short term.

Rather, we believe that property performance will be yield driven; capital growth and through that, total returns being dependent on property yields remaining firm and, in some cases, hardening further. The outlook for the industrial sector remains positive – tenants chasing a decreasing number of available units – at least for the next few quarters.

Development is increasing, but so are costs. Bar for some completing in the coming few months, these cost increases, and in some cases lack of available construction staff and materials may begin to impact negatively on proposed new builds. Some proposed development may become unviable or may have to be deferred thereby further limiting tenant choice and further pushing up asking rents.

The industrial sector

Rarely can a set of drivers have been lined up so perfectly for any part of the commercial property market than for the industrial sector just now: the enforced closure of much of the physical retail space, the necessity of shoppers to buy online and the corresponding massive demand from distributors that has fuelled the growth in rents. Through that, demand from investors has driven yields down to historic low levels. Yet, the industrial sector has for many years delivered above market average returns, generated mostly from the high income return, which compensated for limited rental growth … until now.

Average asset value growth over the last 12 months in excess of 20% in many regions of the UK has propelled this previously unfashionable sector to the top of investors’ must haves. Take up of distribution space is currently running at unprecedented levels with over 21m sq ft let in the first six months of 2021, reaching levels that have become customary for the whole year.

Not surprisingly, the amount of available space has decreased markedly. At a nationwide level, the vacancy rate has dropped to 4.8%, the lowest since records began (source: Savills). Grade A space only accounts for just over a quarter of this amount. Speculative development is picking up, but the estimated 17m sq ft underway is equivalent to only five months take up at the current pace of letting.

The retail sector

While the immediate outlook for rents and yields remains the weakest of the three main sectors, there are glimmers of optimism on the horizon. The collapse in values across the retail space seen over the last few years seems to have come to an end. Rents and values are still falling in high street shops and shopping centres, but at a much lesser pace. But retail yields are firming – the 6 bp fall for average shops and shopping centres being the first quarterly fall in equivalent yields for three years. Add to that the ending of most restrictions so giving a welcome boost to spending on the high street and other physical shops.



One bright spot is the return to favour of retail warehouses. Average rents may still be falling (by just 0.6% in Q2) but yields have now been moving in for two quarters, finally reversing the three-year rise.

The office sector

The office sector is one that has bypassed much debate over the last year or so, not because there has been little of note to discuss – far from it – but more because of the headlines raised by the soar-away industrial values and the depression that has been felt in the retail sector.  Minimal capital movements and mid-range total returns, nevertheless, are commendable during the deepest recession in history and also because many offices have been unused for over a year. The position in central London is covered in some detail in the next section, but here we concentrate on the office markets outside central London, using the MSCI regional definitions.

The drivers of property performance differ across the regions – occupier demand differs everywhere and so too does the quality of existing stock and provision of new stock. Consequently, vacancy rates vary by region, and can move erratically when developments complete and become let. The following charts show the outlying regions in terms of current vacancy levels – both those where vacancies are high and where they are below average.


Unsurprisingly, there is a link between vacancy levels and rental growth. The regions on the left hand chart showing low vacancy rates have recorded positive rental growth over the last year, in contrast to many of those with higher vacancy levels. However, West Midlands, which currently has a vacancy

rate of 20% has recorded the highest rate of rental growth over the last twelve months (2.3%).


Summing up, were it not for the industrial sector, commercial property would have delivered disappointing rates of return, but more in line with what is expected during a recession. The pandemic and the resultant changing shopping habits it created has merely accelerated what has been ongoing for several years.

The outlook for industrial assets looks set fair for some more quarters with still high levels of tenant and investor demand. But the sector is in an unusual situation with ultra-low yields and so remains vulnerable to interest rate shocks and changing investor sentiment. Offices look fairly priced, but much will depend on how quickly businesses decide on their staffing policies and how the business is run. Meanwhile, vacancy rates are edging higher with development adding to the uncertainty.

Our one change in view is to suggest that the retail sector is coming back in vogue. With most restrictions now lifted, the high street is now better placed after years of underperformance. Retail warehouses have already seen yields begin to harden, and though rental growth across the retail sector may be some way off, the sector is beginning to offer a yield/income play.


Central London offices

Both take up and investment transactions have improved markedly since the pandemic caused the effective closure of the market a year past March, but even so, both measures are still off their pre-pandemic highs.

In terms of investment transactions, Q2 deals in the City and West End combined amounted to £3.2bn. This compares with deals of only £590m in the equivalent quarter last year, at the height of the pandemic-induced market closure. This improvement helped both central London office markets to post deals in the first six months of the year well up from that of last year – in the City a rise of 64% and an increase of 25% in the West End.




So far this year, there has been a welcome return of large transactions, i.e. transactions over £100m. In June alone, two transactions totalling almost £1bn completed: the 550,000 sq ft, 18-storey, multi-let 30 Fenchurch Street office building was purchased by Brookfield, the North American investment manager for £635m while the near 300,000 sq ft Minster Building in Minster Court was bought by Far Eastern investors for £353m. Both deals reflected net initial yields of 4.5%. The largest West End transaction in Q2 was the £177m purchase of One Embassy Gardens, SW8, by the Beverly Hills based real estate investment company, again at a net initial yield of 4.5%. These transactions demonstrate that Covid or no Covid, the large deals are back.

However, looking at investment strategies, investors are no longer favouring investment into the London-centric markets as much as previously. The percentage of the total market that is being accounted for by central London office deals has been on a declining trend for over a decade. Clearly, investors have been moving into industrial markets recently, to the detriment of other sectors, but it is striking that the share of the market that central London offices account for has shrunk by more than a half over the last decade.

Uncertainty over the future use of the office is another factor causing investors to look elsewhere. But with the latest IPF Consensus forecasts indicating that investors expect the office sector to start outperforming industrials from 2023, and retail assets from the following year, central London’s share could once again edge back up.


As to be expected in times of below trend lettings, vacancy rates are moving higher. The City’s void rate is now 9.0%, a 10 bp rise in the quarter and 330 bps higher than at June 2020. That vacancy rate is sure to continue rising in the short term with nearly 500,000 sq ft being added later this year on development completions and the release of 290,000 sq ft in the St Botolph building in EC3 by its present tenant, the insurer JLT. The West End is faring slightly better. Its present vacancy rate of 6.8% is 10 bps lower than three months ago but it is still at elevated levels compared to the recent past.



Presently, there are 27m sq ft of developments due to complete in central London by the end of 2024. Of that, just 21% has been pre-let, signifying that there is 21m sq ft of speculative space scheduled to complete in the next 3½ years. That may be an over-estimation of the picture with worker and material shortages likely to delay some completions. Increasing material costs may also cause some developers to defer some of the later projects, but even so, if alarm bells are not ringing now about vacancy levels, they soon will be.

The lettings market continues to see steady growth quarter by quarter. Take up in Q2 in both the City and West End markets was up from that in the previous quarter. The West End is seeing by far the greater interest with Q2 take up almost 10% higher than in the previous quarter, while over the first six months of the year, take up was 20% higher than in H1 2020. In contrast, take up in the City remains modest, its H1 2021 figure being down 14% on the equivalent period last year.

In contrast to investment transactions, which saw a welcome return of the large deals, the lettings market has been dominated by small transactions, particularly those below 10,000 sq ft. It is clear that the bigger employers are still playing a waiting game before deciding on the next move.

However, there are signs that the lettings market is beginning to awake from its lengthy slumber. Space under offer at the end of the quarter (June) has increased significantly from three months ago while several occupiers are reactivating their search for new premises.



Perhaps surprisingly, average rental value growth picked up over Q2. After five quarters in which average rental values fell in both City and West End office markets fell. ERV growth turned positive in the most recent quarter, rents rising by 1.5% in the City and by 0.7% in the West End.



Yield compression rather than rental movements was the driver of capital growth in Q2. Yields in the City fell by 25 bps (from 5.53% to 5.26%) in Q2. Given that the IPD Quarterly Index covers 110 City offices with a total valuation of £4.4bn, such a large inward yield shift shows that it was not just a few, prime properties that benefited from yield hardening – it was a far larger subset where yields moved in. West End yields saw a much more modest inward yield shift of 6 bp average. West End yields are almost a full percentage point lower than those of the City in the MSCI database while, according to Savills, prime West End yields are 75 bps lower than those in the City.




Summing up, it is remarkable just how well the central London office market has weathered the recent storms. Not only has it had to cope with the implications of the Brexit vote, it has had to endure a lengthy period in which much of the office space has effectively become redundant.

Take up and investment transactions are picking up, but remain well below recent years’ figures while vacant space is rising to worrying levels, especially in the City. On many counts, central London offices look fairly priced, as long as general interest rates remain where they are. However, it is difficult to see where rental growth is going to come from in the short term.

High vacancy rates and a poor outlook for rental growth implies that central London offices are vulnerable to changes in investor sentiment and upward yield pressure.


Finally, it is worth considering the wider picture. Most commercial property markets, and certainly those in western Europe, are experiencing not dissimilar features such as lower take up and curtailed development. Huge quantitative easing policies have lowered interest rates around the globe, consequently leading to low property yields and higher asset prices. Under that scenario, London offices look favourably priced against its European peers. According to BNP Paribas, prime West End yields, despite standing at a near all-time low, are now higher than those of Paris, Frankfurt and Milan. Conversely, the continental office markets are generally looking expensive.

All investment and take up data and statistics from Savills, unless stated; all performance statistics from MSCI; all graphs by the author.

Stewart Cowe, August 2021

Not all retail is dying

By | News

With all the negative headlines it would be easy to believe that the retail sector has died and that the physical store is a thing of the past. However, at Lisnagelvin, Derry/Londonderry, 2020 has been a busy year with lettings and renewals despite the obvious hurdles of COVID and Brexit.


At the centre there have been a number of new openings and expansions including McAtamney’s flagship store, Toytown, and Poundland which have created over 60 jobs including construction works which is a real positive for the city. The centre has also welcomed Amazon Lockers and is one of the first centres in Northern Ireland to be chosen for them.


Andrew Murray of Cordatus said: “There is no doubt that the retail sector is facing challenging times and needs to adapt and reposition itself to current trends. At Lisnagelvin through working closely with the tenants and landlord investment in order to achieve this, we are delighted to have welcomed five new tenants to the centre as well as numerous renewals with both McAtamney’s and Poundland expanding in the centre.”


The landlord was advised by Cushman & Wakefield, Pinsent Masons and Johnston Houston.


Lisnagelvin Shopping Centre is a neighbourhood centre of 111,540 sqft with 487 free car parking spaces and anchored by a 24-hour Tesco superstore and petrol filling station and was bought by Cordatus Property Trust (CPT) in 2016.

Economic and Market Commentary – Q3 2020

By | News

Brexit news


Just a few days ago, Prime Minister Johnson apparently ended negotiations with the EU saying that there was no point carrying on unless the EU fundamentally changed its position. Perhaps a week is indeed a long time in politics as talks are very much back on and it appears that the UK and the EU could now be inching towards a deal. It has been reported that compromises from both sides on one of the thorny issues, that of post-Brexit fishing rights, could kick start discussions that would enable a trade deal to be unveiled before the year end.

The compromise would allow the UK to regain control of its territorial waters while also allowing EU fishing boats access. It is reported that the protagonists are looking at a plan which uses the concept of ‘zonal attachment’ where quotas are determined by the amount of fish stocks on either side’s waters. If a deal is reached, it would allow British fishermen to catch significantly more fish than at present and it would also defer the decision on the amount of the EU quota until after the wider trade deal is signed.

Talks are continuing with both sides accepting that the clock is ticking with some tough negotiations still to come. But the fact that discussions are still ongoing is a welcome development.

Meanwhile the UK and Japan have signed a trade agreement, Britain’s first post-Brexit trade deal. It means that virtually all of Britain’s exports will be tariff free while tariffs of Japanese cars entering Britain will be tariff-free from 2026.

While symbolic, the trade agreement would boost trade between the two countries by about £15 bn – adding less than 0.1 percentage point to the UK’s GDP – a tiny fraction of the trade that could be lost were no deal with the EU be agreed.


Global economy

It is fair to say that we are all experiencing difficult times, perhaps the most challenging since the Second World War; challenges where economic policy alone is insufficient. Many countries are experiencing a ‘second wave’ of Covid-19 cases, testing has been ramped up across the globe and social restrictions are being reimposed; still the death toll rises, still we await a suitable vaccine and governmental spending still spirals relentlessly upward.

Despite this gloomy environment, economic forecasts for 2020 are generally better than those predicted three months ago, following on from slightly less damaging contractions in the second quarter, but these minor upgrades have been counterbalanced by the expectation of a weaker recovery next year.

The relatively stronger Q2 outturn has been helped by the sizeable, quick and unprecedented fiscal, monetary and regulatory responses that has helped maintain disposable income for many affected households and protected cash flow for businesses. Collectively, these actions have so far prevented a recurrence of the financial meltdown of 2008-10. How governments are going to pay for this largesse is a tetchy question for the future. At least, the probability of low interest rates for a longer period together with the anticipated recovery next year alleviates the debt service burdens in many countries.

While the worst in terms of economic fallout is now, hopefully, behind us, the pace of recovery is likely to be lengthy, uneven and uncertain. Many countries are now facing a second wave of infections, once again putting severe strain on health services and any hope that the illness and its economic impact would be confined to 2020 now seems unlikely. Indeed, the number of new cases in many countries is currently rising at a faster rate than during the initial February – April phase although one has to bear in mind the number being tested now is significantly greater than six or seven months ago. This has caused a further downgrading of the economic outlook for many countries in the near term compared to pre-pandemic expectations. 



Our global economic forecast for 2020 has improved from -4.9% three months ago to -4.4% with upgrades to our forecasts for the US (by 3.7 percentage points), the eurozone (by 1.9 pp) and Japan (0.5 pp). All these upgrades are followed by slight downgrades next year. The risks remain very much skewed to the downside, most visibly seen in the sudden falls in global stock markets at the end of October when markets started factoring in a much worse economic consequence of the ‘second wave’.

After a partial recovery next year, global growth is forecast to gradually slow to around 3.5% pa in the medium term, somewhat short of the c 4.0% – 4.5% pa anticipated pre-pandemic. The reduction in the growth outlook will hit average living standards and the pandemic will reverse the near three decades of progress in reducing global poverty and will increase inequality, particularly hitting those working outside the formal safety nets. 

Nonetheless, the interminable US circus called the election is over – bar the shouting! – for another four years. While not quite overshadowed by Covid news, the election of Jon Biden (subject to potential litigation by Trump) is likely to change many of Trump’s policies, including tax increases for both high earners and corporations. Only time will tell, as will dissecting ex-President Trump’s tenure. Staying in America, though with global ramifications, the Federal Reserve indicated that there would be no interest rate increases until at least the end of 2023 adding that it would not tighten policy until inflation has been “moderately above” 2% “for some time”. Its Chair, Jerome Powell said the statement meant “rates will remain highly accommodative until the economy is far along its recovery from the Covid-19 pandemic”.




The EU economy

The eurozone and EU recorded a stronger than anticipated recovery in the third quarter, the former posting growth of 12.7%, fully three percentage points ahead of expectations. This followed two quarters of decline which in total had left the zone 15% lower than at the start of the year. But any hope that the single currency bloc could build on this recovery in Q4 have been derailed by new lockdowns or circuit breakers which have been imposed in many countries in recent weeks.

Expectations for Q4 are being reduced with some commentators believing that a double dip – i.e. further contractions in activity – could be on the cards. Certainly, the restrictions re-introduced will have an adverse effect but a slowdown was already being seen. France’s finance minister is on record saying that the French economy will contract by a worse than expected 11% this year. Meanwhile, German consumers are tightening their belts. The boost from the cut in VAT is fading, pushing retail sales down 2.2% in September. 


Meanwhile, owing to the job retention schemes that were introduced earlier this year as Covid-19 became established, the rise in unemployment has so far been limited. Over the third quarter, the euro area’s unemployment rate was 8.3%, 30 bps higher than that three months earlier and 80 bps above the rate 12 months ago.

Inflation turned negative in August and at -0.3% in September remains well below the ECB’s target of ‘close to but below 2 percent’. Oil prices have been particularly weak recently as markets consider the financial and economic impact of further lockdowns, and they are likely to remain weak for the foreseeable future putting further downward pressure on inflation.

Our forecasts have been increased slightly for this year but reduced by a small amount next year for most countries. However, with many European countries now in the midst of a tightening of restrictions, there is a real fear that Q4 growth (and consequently for 2020 as a whole) will be significantly lower than that expected.





The UK economy

A 20% contraction in the second quarter was not part of Boris Johnson’s manifesto a year ago, but then, the terms coronavirus and Covid-19 had not yet become part of everyday conversation. Not only was the fall the worst quarterly result in UK history, it was the worst performance by any G7 country, and one of the worst posted in the developed world. With the UK’s record on the number of Covid-related cases also one of the worst, it has not been a 2020 to remember for the government.

Predictably, Q3 saw a major recovery, but momentum has since stalled as the virus reasserts itself in the community forcing significant tightening of the economy. The magnitude of the recovery remains uncertain, with the first, flash estimate expected later in the November. Expectations for Q3 growth range from 13% to 18%.  Hopes for Q4 have been lowered in line with other European countries and another contraction cannot be ruled out. It is likely that the full year outcome will be a decline of around 10%, by far the worst outcome seen since the immediate aftermath of the Great War but similar to other countries in the continent.

Meanwhile, the furlough scheme, which pays workers affected by the forced, temporary closure of businesses, and which was due to end on 31 October and be replaced by a less generous job support scheme, has been extended until March 2021, meaning that the scheme will have been in place for 12 months. Around 9.6 million workers have benefited from the scheme since its start this March at a cost to taxpayers of £40bn.

Unemployment has also risen to its highest level in over three years as the pandemic continues to hit the economy. The unemployment rate increased to 4.5% in the quarter, up from 4.1% in the previous quarter. Similarly, the number of redundancies in the last three months increased to 227,000, the highest since 2009 in the midst of the financial crash. These statistics are not as bad as were initially feared at the start of the hiatus when talk of an increase to an unemployment rate of 9% was rife. But with the second wave of infections now upon us, further and significant job losses are likely.

With the pandemic no nearer to its conclusion and its financial impact no nearer being finalised, the Chancellor has taken the sensible step of postponing this year’s Autumn Budget. ‘… now is not the right time to outline long-term plans – people want to see us focused on the here and now,’ the Treasury said. That means that the difficult decisions on how the cost of fighting Covid is to be financed has been deferred into the new year.

On the day lockdown restrictions were imposed in England, the Bank of England announced another £150bn of quantitative easing, taking the total employed this year to £895m, dwarfing the amounts utilised in the past decade. The Bank acted as it was concerned that the UK would enter another downturn as the new restriction hinder the recovery. Interest rates were kept at their record low levels, 0.1%.



This second period of lockdown in England should not be as damaging to the economy as the spring one was for several reasons: presently, the period of lockdown indicated is only four weeks as opposed to the uncertain period when the first lockdown was announced in March; unlike the previous period, manufacturing, construction, real estate, schools and universities, nurseries and garden centres are allowed to open. The four-week lockdown is due to end on 2 December, and that therefore affords the possibility of a re-opening in the run-up to Christmas which would obviously be of major benefit to retailers. Additionally, lessons have been learned both from communications and working from home. All that should point to a less damaging impact to the economy in December than what happened earlier in the year.

Summing up, the economy has made a strong recovery in Q3 but momentum has slowed in recent weeks pointing to a weak Q4. As the Covid case numbers remain elevated, a fresh lockdown across much of the UK will further hinder growth while it is likely that the economy will not reach its pre-Covid level until 2022. Meanwhile, the cost to the Treasury keeps mounting. How the Chancellor tells us how we are paying for the unprecedented measures introduced over the last eight months has been deferred until next year. 



Market Commentary

A 1% fall in average property values over Q3 took the cumulative fall in values to 10%. This period of declining property values started two years ago, making this decline of similar length of time to that over which values fell during the global financial crash. Perhaps the same duration, but thankfully, not the same magnitude, as average values fell a whopping 44% a decade ago. But whereas property values started to rise two years after the decline started in 2007, there are few signs of respite in the current collapse. However, the 1% fall in Q3 was significantly less severe than in the two previous quarters and gives hope to the belief that the end of the decline may be near. Much will depend on the strength of the economy in the coming months.



While most areas of the market are witnessing falls, it is the retail sector which is bearing the brunt. Once again, the shopping centre segment was the worst performing over the quarter, falling in value by 6.6% for a cumulative fall of 24% this year alone. The fate of standard shops was not much better, seeing a 3% fall in the quarter. Neither segment was helped by the news that the number of shop units closing in the first six months of the year hit an all-time high with 6,001 closures, up from 3,509 in the corresponding period last year.

It is not all doom and gloom on the high street, though. There are a few bright spots too, as there is a steady flow of openings. For example, consumers are rediscovering their local retailers while there has been a mini boom in takeaway and pizza delivery shops. Additionally, there is rising demand for services such as tradesmen’s outlets, building products and locksmiths. These new units, welcome though they are, however, are dwarfed by the numbers closing. There is still a lot of pain to come for the retail sector; a lot of corporate restructuring and many more redundancies to come, despite the Chancellor’s laudable efforts on job protection.

From a performance measurement point of view, institutions, which are most likely to favour investment in city centre retailing units, are often not represented in neighbourhood shops and parades and so it is debateable whether valuation upticks in these local shops will work its way into the MSCI (IPD) indices.

One of the success stories this year has been the growth of internet sales, though that of course has had negative implications for the high street. As retailers have been augmenting their online presence, there has been significant growth in retailer interest in distribution warehouses and also investment by these retailers in the final part of the supply chain known as the ‘last mile’. This is fuelling growth in these smaller distribution warehouses in suitable locations nearer the customer. It is no surprise that these parts of the commercial property market are presently the strongest. Average industrial values bucked the recent trend in Q3, posting an increase of 1.0%, the only sector to show an increase, with the sector back in growth after six months of decline. 



From success stories to failure! Business recovery firm Begbies Traynor claims that there are now over half a million firms in ‘significant distress’. Needless to say, the biggest increases in struggling companies came in food retailers, construction and real estate and property sectors. And that number could be even higher if courts were operating normally, as the number of county court judgments and winding up provisions are lower as winding-up petitions for Covid-related debts are currently banned. That has led to concerns that, once these restrictions are lifted and Government support is removed, the number of firms going bust could surge as a ‘brutal reality check’ hits the UK economy. Many of these companies are surviving only through the availability of Government loans and employee cost subsidies, but once these come to an end, there will be little hope for many of them.

Investment transactions were notably higher in Q3 than in the depressed second quarter. Total deals in the country totalled £6.5bn (source: LSH), almost 50% higher than in Q2 but still 50% lower than the five year quarterly average. September accounted for over 40% of Q3 deals, perhaps indicating that the market is now beginning to pick up after weakness over the spring and summer.

Surprisingly, investment activity was driven not by London but by provincial deals, where the volume of deals was down only 28% from its quarterly average. This compares with a 50% reduction in central London office transactions. Offices were the most favoured sector in the quarter where deals amounted to £2bn were recorded: industrial properties also remained in vogue with deals worth £1.9bn transacted in the three months while retail assets were again out of favour with less than £1bn transacted for the fourth quarter in a row.

Although activity was relatively muted in London, it was home to the quarter’s largest transaction, the purchase of Morgan Stanley’s headquarters in Cabot Square, Canary Wharf for £380m. The purchaser was a Hong Kong-based REIT. The next two biggest transactions in the quarter were also offices – Sun Ventures purchase of 1 New Oxford Street for £174m and Tristan Capital’s £120m purchase of Reading International Business Park. As debate continues as to the future of offices in the post-Covid world, these purchases are major statements by the purchasing funds concerned. 

Summing up, the property market enters the winter season in much better shape than at any time since the outbreak of the pandemic earlier this year. Take-up and investment statistics remain dull, but are on an upward trend following extremely weak figures over the summer. Anecdotal evidence of the amount of lettings and investment transactions also points to an improvement in the final quarter of the year. But perhaps the most positive feature to emerge over the course of Q3 was the sudden slowdown in the rate at which average property values are declining. The rate of decline in property values had been accelerating for four successive quarters. The outturn for Q3 was significantly better than those recorded over the previous two quarters and gives a glimmer of hope that the two-year decline in property values may be near an end. Whether that is the case will largely depend on the state of the economy, whose outlook is as confusing as ever. Not only do we have potential lockdown-induced weakness but we also have the ‘deal / no-deal’ discussions with the EU. It will be an interesting couple of months. 

Central London offices

With the economy struggling to regain momentum, it comes as no surprise that take up of central London office space currently remains muted, although Q3 was stronger than in the almost moribund second quarter. Vacancy rates have been rising over the course of the summer for three reasons: below average take up, the fact that new Q1 2021 completions now come into the equation and from a significant increase in tenant marketed space.



In the City and West End combined, the amount of tenant released space available for sub-leasing increased by over 1m sq ft to almost 4.9m sq ft over the course of the quarter. This amount is three times that available before lockdown and now accounts for one-third of the total amount of space available in central London. With many businesses facing unprecedented uncertainty over their futures, it can be expected that this space will continue to grow in the coming months. 

Overall take up is recovering from its earlier slumbers with September figures for the City and West End showing welcome improvement from recent months. That said, though, cumulative take up for both Q3 and for the first nine months of the year remain well below recent comparables. At just over 500,000 sq ft, the City take up in Q3 was the lowest Q3 for 16 years, while the West End take up, at just under 400,000 sq ft, was the lowest third quarter lettings this century. 



Confidence in the investment market is also slowly but surely improving. Total investment deals across the two central London office markets in Q3 amounted to £1.27bn, double that of the previous quarter, although it is still way below pre-Covid levels. The acquisition of 1 New Oxford Street at a yield of 4.2% has already been referred to, but that was eclipsed as the largest deal in the quarter by the purchase of the Morgan Stanley headquarters in Canary Wharf for £380m. Both strong statements as to the future of the office post Covid.



Capital values are still under downward pressure, but the rate of decline in Q3 was less than in the two previous quarters. Average City values fell 0.5% while those in the West End by 1.1%, bringing the cumulative fall this year to 1.8% in the City and 3.6% in the West End. Rents, though, are faltering. Prime City rents, at £77 per square foot in September are 4.6% lower than three months earlier and 12% lower than 12months ago. West End prime rents remain around £100 psf.

Summing up, the central London office market has weathered the recent storms relatively well.  Take-up and investment transactions are recovering though still well short of recent levels. While many of the statistics are moving in the right direction, the increasing amount of tenant marketed space is a worrying development. Central London offices are still vulnerable to the failure of the Brexit discussions and to the debate over the future role of offices versus home working. In the short term, further weakness in rents is likely.

All investment and take up data and statistics from Savills, unless stated; all performance statistics from MSCI; all graphs by the author.

Stewart Cowe, November 2020

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