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Gavin Munn

Cordatus ESG Award 2022

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Cordatus is pleased to reveal this year’s winner of the firm’s annual GRESB award.

Neil T has embraced the Cordatus and CPT ESG agenda with enthusiasm and is currently driving forward the 2023 GRESB submission.

Neil’s ESG work during 2022 was varied and included preparation of a Cordatus EPC Portfolio Policy paper; maintaining, updating and organising EPCs for assets to keep a record of all EPCs for the portfolio; installing a bug hotel, bird boxes and hedgehog boxes/nests in the grounds at an asset in Leeds and working with charities at Park View, Whitley Bay which also received a Gold award for Health & Safety from RoSPA.

So well done Neil, a £100 Amazon Voucher is winging its way to you!

Economic and Market Commentary Q1 2023

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The Global Economy

While the lingering effects of the Covid-19 pandemic are still impacting global economies, it is the indirect effects of the Russian invasion of Ukraine – high energy prices, high levels of inflation and consequently high levels of interest rates – which are currently of more importance.

Pent up demand, continuing (although lessening) supply chain disruptions and high commodity prices have all created the environment for acute price inflation which have recently hit multi-decade highs around the globe, and which in turn have led central bankers to aggressively tighten monetary policies in an effort to bring inflation back towards target levels.

Following many years of ultra low levels of interest rates, this sudden switch of tack has caught out some parts of the financial system, most noticeably in the failures of several regional banks in the US and in the loss of confidence in the global player Credit Suisse. These, hopefully isolated cases aside, the financial system is now better prepared and better capitalised to withstand such systemic shocks such as rapidly increasing interest rates, but bank stocks remain vulnerable to further shocks.

Despite all these headwinds, activity in many countries turned out better than expected in the second half of last year, typically brought about by stronger than anticipated domestic conditions. Labour markets have stayed strong and unemployment rates remain low. Nevertheless, confidence in many countries is currently lower than that prior to the start of the Ukrainian conflict.

The future direction of global economies remains shrouded in doubt. Uncertainty remains elevated and the balance of risks, mainly through renewed concerns over the banking system, has moved even more to the downside.

Our global growth forecasts see a further 10 basis points (bps) trimmed from both this year’s and next year’s expectations compared to our views three months ago, but starkly, our new forecast of 2.8% for this year marks a significant downgrade of 1 percentage point (pp) from our expectations for 2023 made immediately before the outbreak of war.

The EU Economy

GDP growth in Q1 of 0.1% following the previous quarter’s flat-lining certainly ensured that the euro zone escaped falling into recession. Recent surveys point to a more upbeat second quarter but even so, the odds are strengthening of a slowdown and possible recession in the second half of this year.

Industrial activity has been the main contributing factor to the zone’s resilience recently, benefiting from a large backlog of orders and helped by reducing supply problems. This catch-up boost to output will end soon, more so if demand continues to drop.

Of particular concern in the Q1 data was news that retail sales fell by 0.4% compared to the previous quarter leading to the likelihood that total household consumption will also have contracted in the quarter. That decline followed a 0.9% fall the previous quarter. Compounding this reduction was news that the sales decline accelerated in March when sales were 1.2% lower than in February.

Industrial production struggled in March after rising the two previous months. French industrial output fell by over 1% in March while a near 3% fall in manufacturing output in Germany is a signal that its industrial output will also be down. A huge fall of almost 11% month-on-month in industrial orders in the zone’s biggest economy in March was the country’s biggest monthly fall since the first Covid lockdown three years ago and this has reduced orders to their lowest since August 2020.

Further interest rate increases are expected from the European Central Bank, following May’s 25 bp increase, which would pile even more pressure on hard-pressed households and businesses.

Compared to our previous report, we have increased our GDP expectation for the euro zone this year by 10 bps but lowered the 2024 expectation by 20 bps. As with our forecasts for other economies, risks to these forecasts lie firmly on the downside.

The UK Economy

The UK, once again, grabbed unwanted headlines in April when, according to the IMF, Britain would deliver the worst economic activity over 2023 in the G7 group of countries. Commentators conveniently forgot the fact that the UK enjoyed one of the strongest levels of growth in the G7 last year and looking at the cumulative growth over last year and this, the UK comes out third of these seven countries and two full percentage points of growth greater than the worst performing economy by this measure, Germany. The IMF’s new UK forecast contraction of 0.3% for 2023 was, though, a little better than the organisation’s previous forecast of -0.6%.

But much has changed since the publication of the IMF’s report. Recent data suggests that a recession (defined as two consecutive quarters of negative growth) may be avoided this year; albeit current expectations for a year’s growth of around 0.2% would still indicate only an anaemic performance. By contrast, Britain’s stubbornly high rates of inflation, where annual rates have now been above 10% for nine consecutive months, suggest that at least one further increase in base rates can be expected, perhaps as soon as the May meeting of the Bank of England’s Monetary Policy Committee. That outcome is certainly worse than expectations three months ago.

The more optimistic view on the economy can be seen from the recent uptick in the Purchasing Managers’ Index, which has indicated an expansion of activity for the last three months. The April figure was the highest since April 2022. Further good news has emerged from a rise in consumer spending, defying expectations of a contraction owing to the cost-of-living crisis.

The inflation picture remains depressing. Sustained annual rates above 10% were not what was anticipated. Retailers and economists believe that the increase in food prices – the key reason for the recent high rates – will soon reverse. Dismayed shoppers will only believe it when they see their weekly shopping bills start falling. Commentators now no longer suggest that inflation will revert to target this year, but have indicated that it will not be until the end of 2024 before the 2% level is hit.

Meanwhile, news that business failures surged again over Q1 was a timely reminder that the current economic backdrop remains hostile for many businesses. Company failures in England and Wales hit 5,747 over the first three months of the year, 18% higher than during Q1 2022 and one of the highest quarterly figures in 60 years of compilation (source: Azets Accountants). Further increases in interest rates will only compound the problem.

The jury is still out on whether the UK can avoid a recession, or indeed if it can even post growth for 2023. There remains a wide spread of GDP forecasts for this year (ranging from a low of -1.5% to a high of 0.5%), but in the main, these have been improving since the immediate aftermath of the then-Prime Minister’s botched growth plan in September. It should be noted that Chart 2 and Table 3 below were compiled between the 4th and 14th April, since when survey data has appeared more optimistic.

In line with previous reports, we adopt the views of the IMF, which forecasts that the UK economy will contract this year by 0.3%. The small difference between the IMF’s expectation and the above consensus figure is well within rounding errors.

Market Commentary: stability returns to the market, but for how long?

Given the renewed concerns over the banking system which surfaced in March and which the industry has since been unable to quash, it was perhaps surprising that returns from commercial property that month turned positive (source: MSCI Monthly Index, March). Maybe, in the same way that the bond market hiatus of last September was only felt in the commercial property market the following month, a similar story will emerge for returns in April.

Nevertheless, after eight months of declines, average property valuations returned to growth in March – albeit a miserly 0.2%. But drilling down, growth remains patchy. Retail warehouses and industrials – the elements of the property markets which enjoyed strong growth in the bull markets prior to mid-2022 (and coincidentally, the areas of the market that had the biggest falls over these eight months) were the only main segments to show any growth. (The ‘other’ sector, comprising a disparate mix of assets such as leisure, health and hotels also recorded growth, of 0.3%).

The 1.3% increase in average retail warehouse valuations helped all retail assets to increase by 0.8% over March while the average industrial asset increase that month was 0.7%. Offices remain very much in the doldrums. A 1% fall in March takes the Q1 decline to 3.1% and a fall of 17.7% from its peak.

Looking at the performance of the Quarterly[1] Index, the Q1 rental growth picture was positive, as can be seen in Tables 5 and 6. Conversely, only retail warehouses managed to post positive capital growth. Every segment of the market is witnessing growing rents over both the last three months and 12 months. Standing out once again is the industrial sector which recorded average rental growth of 1.8% in the three months to end March and a remarkable 8.7% over the last 12 months.

[1] The Quarterly Index is published every three months & comprises 8,222 UK commercial properties, valued at £142bn. The Monthly Index is much smaller, a total valuation of £29.7bn across 1,561 properties and is published monthly. The Quarterly Index includes properties which are valued at least four times a year while the Monthly Index includes only properties which are valued every month. While much smaller and less representative of the wider real estate market, the Monthly Index can provide a more dynamic view of turning points in the market.

Only one segment has seen its average property values increase over 2023 so far – retail warehouses with growth of just 0.8% while over the last 12 months, no segment has managed to contain the fall in values to less than 10%. Over that period, the best performing segment was shopping centres with a fall in average values of 10.9%

These tables confirm that the property story has all been about the rapid yield unwinding, particularly over Q4 2022, but still evident during the most recent quarter. Over the last three months, yield expansion was still evident across every sector and segment bar retail warehouses where yields hardened by 8 bps to 6.69%.

Surely not another GFC-type crash?

Some commentators are comparing the troubles facing the US regional banks to the liquidity and solvency crisis of the Global Financial Crash. The collapse of several specialist and regional US banks and the forced takeover of Credit Suisse ought not imply that the entire banking system is broken. As stated before, banks are better capitalised now and their loan to value figures are much more benign this time.

That said, one must be aware of the potential risk these US regional banks place on the wider economy. This group of banks are far more exposed to commercial property lending than their European (and UK) counterparts: in Europe, commercial real estate accounts for roughly 7% of banks’ loan books compared to 13% for the larger US banks and 43% for these regional US banks. Hence the worry that failures of these smaller institutions could prove problematical for commercial real estate.

What is alarming, however, in this digital age, is the ease and speed that individual depositors’ money can be moved away from any institution that appears vulnerable. Whereas most commentators had believed the shake out would have been cured by the quick and pro-active central bank action, lingering doubts about the viability of some regional banks remain. As each week passes, further doubts about specific institutions emerge, creating a similar measure of distrust that was prevalent in 2007 and 2008. These regional banks are not subject to the rigorous stress testing that applies to the main US and European banks. Another reason why rapid changes of sentiment to these regional banks occur.

Coupled with a likely rise in UK interest rates, this renewed concern about the solvency of these banks has certainly affected the immediate outlook for UK commercial property.

From property’s point of view, yields which have seen sharp outward movements, most noticeably during the last quarter of 2022, seem to have stabilised with the MSCI Monthly Index for March showing very small uptick in average capital values – the first time since June last year. Further yield slippage, though, cannot be ruled out, particularly given the distinct possibility of further increases in UK base rates. That said, any further increase in property yields should be relatively minor and not at the levels seen in Q4 2022. As mentioned above, property valuations are also being supported by relatively strong rental growth, particularly in many industrial markets and in some office locations.

Interest rates in many countries have been ratcheted up since our last report. The increases from the Federal Reserve and from the European Central Bank and the probable increase from the Bank of England later this month had not been factored in three months ago. In the UK’s case, increases will certainly impact the commercial property market, increasing the cost of debt and making some developments and some debt-fuelled investment purchases unviable. As stated earlier, property yields, having appeared to stabilise, may nudge up a little. It is noticeable that the 10-year government bond yield is roughly 50 bps higher than it was three months ago, reflecting the Bank of England’s fight against the higher-than-expected inflation.

That change in the UK’s macro picture is likely to impact the outlook for commercial property. Directly, through higher property yields and indirectly, through changes in the risk premium required by investors. Stock markets have been extremely volatile, some investors are adopting a ‘risk off’ approach, seeking ultra-safe assets. As noted in the following paragraph, property investors continue to sit on the sidelines, so what will tempt them back in? Will property yields need to move even higher for them to do so? Having said that, property fundamentals remain supportive. The recent shake out has undone much of its over-valuation, rents are still edging up while development, by and large, is modest.

Total investment over the first three months of the year was just £8.3bn, 55% below the equivalent period last year and the lowest Q1 figure for 11 years. Compared to the first three months of last year, industrial deals were down 80% and office transactions were less than half last year’s. Only in the retail sector did the volume of deals approach those of Q1 2022 – but retail transactions of £1.9bn included Sainsbury’s £431m portfolio deal, more of which can be read in the retail section later in this section.

Given the speed and extent to which market rates of interest have been rising – twelve months ago, base rate was just 1.0% – vendors and buyers have not been quick to adjust to the current levels. Sales that completed during Q1 were predominantly put on the market last year while open marketing of new properties for sale remains limited. This all suggests that Q2 transaction figures will also be modest. One hopes that after the traditional summer lull, more certainty about the levels of interest rates will attract increasing numbers of participants to the market over the last six months of the year.

As the cost of borrowing has increased, the amount lent by banks has slowed, particularly with lending for development projects. Net lending for developments has been negative for each of the last nine months (and for 26 out of the last 29 months) (source: Capital Economics) suggesting that the provision of Grade A properties over the medium term will be limited. This net reduction in bank lending is not simply down to the banks’ reluctance to lend – the rising costs of materials and higher financing costs are making many potential developments unviable. That said, the reduced number of developments in the future highlights the fact that, at current levels of take up and demand, the provision of Grade A space in the coming months is unlikely to keep pace with demand. This augers well for prime rental growth in the coming months and years.

Total returns stabilised over Q1 despite acute volatility in March following the initial burst of concern for the solvency of some US banks. At least total returns were positive (commercial property delivering a minimal 0.1% total return over the quarter) but property’s poor performance over the previous quarter ensures only modest rates of return over the longer term.

The industrial sector

Industrial assets bounced back over Q1 following its fall from grace in Q4 2022. Growth in valuation terms, though, was accompanied by lower take up and investment deals. Take up dropped 15% to 8.6m sq ft from the previous quarter and Q1 was the third successive quarterly decline (source: Colliers Marketbeat, Q1 2023).

This fall in take up was accompanied by a change in tenant composition. There were fewer large tenancies signed with an increase in smaller units, as logistics companies and retailers sought to acquire space to safeguard against supply chain disruption and manufacturers continued to increase their near-shoring and re-shoring operations. Medical sector occupiers have recently been ramping up space requirements, helped by the UK pharmaceuticals and life sciences sectors.

Availability has risen over the quarter, up 7% in the three months to 60m sq ft (source: Colliers Marketbeat), yet supply remains tight. Development, too, is increasing. Currently, Colliers reckon that over 200m sq ft is being built speculatively, an increase of 40m sq ft in the quarter.

Q1 investment transactions were the lowest first quarter figure for ten years but sentiment seems to be improving as investors note that average equivalent yields have risen by over 125 bps (to 6.15%) over the course of the last nine months (source: MSCI Quarterly Index).

The retail sector

A better than feared Christmas season has brought some optimism back to the retail market. While still suffering from the cost-of-living crisis, recent sales data has been encouraging with some retailers, particularly fashion operators, announcing expansion plans and/or moves to reopen outlets in locations where they had previously operated.

The squeeze on consumer spending shows little prospect of an early conclusion, but as inflation subsides, retail spending should recover. Spending will benefit from the low levels of unemployment and when wage growth, at some point, once again outstripping inflation.

Investment in retail assets was not as badly hit in Q1 as the other sectors, down just 19% to £1.3bn. But as indicated earlier in this report, a sizeable portion of that investment was attributed to a portfolio deal by the grocery chain Sainsbury to buy the freehold of some of their supermarkets. Sainsbury spent £431m buying the 51% of the Highbury and Dragon REIT they did not own, which contains 26 supermarkets and which are all leased back to them. Sainsbury clearly took on board the comment in our last report which stated that supermarkets were an attractive proposition following the 13% fall in valuation over Q4.

The office sector

Occupier focus across Britain continues to be on prime space. Part of the rationale is to be able to attract, retain and engage staff while ESG considerations are also playing a role with companies becoming increasingly aware of their own carbon footprint.

Fears that the days of the office were numbered, following the work-from-home mantra of the pandemic, seem to be overdone. According to the Office for National Statistics, almost one-in-three office workers now opt for hybrid working, more than double the number who now work solely from home.

Demand for the best office space is noticeable across every major centre in the UK, although some occupiers are marrying this requirement with shrinking the amount of space needed. A combination of slightly lower levels of take up and continuing development have pushed vacancy rates up in just about every main office centre, rising to about 8% in central London and between 5% and 7% in the ‘big-6’ office locations, about 1 pp higher than the five-year average.

Summing Up

We were optimistic three months ago that the sharp downward lurch on property values was at an end. Since then, muted levels of take up and investment were not unexpected given the still uncertain path of interest rates and economic growth around the world.

What has changed over the last three months, however, is the appearance of another ‘black swan’: that of the health of the US banking system. Whereas it was initially expected that any damage to the financial system would be soon contained, as we write, further concerns continue to break, casting a shadow over the outlook for the US economy.

While this issue seems mostly to involve the US financial system, the UK is impacted, if only by sentiment. Additionally, high inflation is pushing up interest rates further than had been expected. Property yields will correspondingly be under further (slight) upward pressure, potentially delaying the embryonic recovery.

Property fundamentals remain supportive. The recent (Q4) shake out has removed much of the over-valuation that had been evident for some time while take up, though weaker than previously, has been quite resilient.

Going forward, much will depend on how successful the Bank of England’s fight against inflation is and how much higher interest rates need to go. The US regional bank issue clearly muddies the water, but directly, will have little impact on commercial property in the UK. Indirectly, it will, and sentiment will play an important role in how investors perceive risks in real estate assets.

The outlook for UK commercial property on a medium-term view looks favourable. What is uncertain in its trajectory over the immediate short term.

Central London offices

The fact that letting statistics and investment transactions are running well below recent levels should not come as a surprise. Uncertainty over the future path of interest rates, made worse by the hiatus last autumn over the ‘mini budget together with more recent overseas banking troubles have cast a shadow over what traditionally is the most volatile of property segments.

London is not the only key office market to be affected by such worries. European office markets, including Paris, Frankfurt and Milan are all seeing slowing levels of take up and investment transactions. Savills research shows that prime city office values have fallen across Europe since the beginning of 2022 ranging from a fall of 33% in Amsterdam and Berlin to an as-yet less badly hit Bucharest which has seen a modest 9% fall. For comparison, Savills state that City of London prime values have fallen 22% while prime West End values have fallen 18% (in both cases more than the MSCI Quarterly Index’s City office fall of 15.9% and West End’s fall of 10.4% over the same time frame).

MSCI’s monthly data shows that average central London office values have been declining for the best part of a year – for 11 months in the case of City offices and nine months for West End offices – and short term, further valuation falls can be expected. Outward yield movements are the principal contributing factor to these declines, as rents – both at the MSCI ‘average’ office level and at the prime end of the market – are remaining not just remarkably resilient but are still increasing.

One key message that recent take up figures are showing is that of many tenants seeking ‘best in class’ accommodation. Over half of the space let in central London over Q1 was of BREEAM[1] standard ‘Excellent’ or above. And it is not just the large global firms that are favouring such properties; over a quarter of such space let in the City over the first three months of the year was to tenants acquiring space between 15,000 and 25,000 sq ft. It is this focus that is likely to keep prime rents firm over the near term, almost irrespective of rising supply. The same cannot be said for poorer quality space. There will always be tenants seeking ‘cheap’ space, but with the minimum energy efficiency standards (MEES) now in force, some older, inefficient buildings will become unlettable and would have to undergo modernisation.

Take up both in the City and in the West End in Q1 was well down on the 10-year averages (by 21% and 20% respectively) but perhaps surprisingly, the West End take up of 792,000 sq ft was 7% higher than that over the same quarter of 2022. Emphasizing the point that tenants are seeking quality accommodation, 92% of City lettings in the quarter were for Grade A space while four out of the five largest West End deals in Q1 were pre-lets.

A feature of recent reports has been the lengthening transaction process, which has impacted negatively on completed deals. This, though, gives some certainty about future levels of lettings. Both in the City and the West End, the amount of stock under offer at the end of March was well ahead of historic quarterly levels. Over 2.5m sq ft was under offer across both sub markets, an increase of 50% from the long-term average. That gives some comfort that levels of take up will improve throughout the year.

As reported in the previous section, rising interest rates together with increases in the costs of building materials have delayed the start of some developments. Nevertheless, the amount of space anticipated to come to the central London office market in the next four years totals 27.5m sq ft, which, though 1m sq ft lower than that expected three months ago, is well up on historic levels. Of that, 21% has been pre-let, signifying that around 21.5m sq ft is speculative. Coupled with high vacancy levels at present which are equivalent to a similar amount of space, that is a lot of potential space to fill. Take up in the City and West End offices markets combined over the last 10 years has averaged 10.6m sq ft; the potential future supply of roughly 42m sq ft therefore equates to four years of demand – a quite daunting statistic.

[1] The Building Research Establishment Environmental Assessment Methodology measures the environmental impact of an asset in the built environment.

Valuations continued to slide in the first quarter of the year, but not at the extreme level of the previous quarter. However, a pricing standoff between buyers and sellers remains. Consequently, central London investment deals were sharply down over Q1 compared to the same quarter of 2022 and that of the long-term average. The West End was particularly affected by the slowdown, with only 13 deals totalling £713m occurring in the quarter. Notably, the sellers of all these properties were UK owners.

Like the lettings market, investment deals are taking longer to crystallise. Every property bought in the City during Q1 was under offer at the end of last year. A total of £1.25bn of offices are presently under offer there – almost half is accounted for by two City offices – while there is further evidence of UK investors forsaking the West End as UK owners account for two-thirds of all the openly marketed properties so far this year. Whereas UK investors are selling, Asian investors are buying, particularly GIC (the Singapore Sovereign Wealth Fund). In February, GIC bought 75% of the Tribeca development scheme in NW1, adding to its purchase of Paddington Central last April. Taken together, GIC have accounted for 20% of the total West End transactions by value over the last 12 months.

The performance of City offices and West End offices has been diverging for some time and Q1 2023 was the clearest example of that. The total return of West End offices over Q1 was -1.0%, substantially better than that of the City’s -3.7%. Over the last 12 months, there is a 5½ pp difference between the office markets- the latter delivering a return of -11.2% against the former’s -16.7%. As indicated earlier, rental growth is stronger and the outward yield shift less pronounced in the West End market.


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


Stewart Cowe, May 2023


ESG Award 2021

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The annual Cordatus ESG award has seen some high quality and thoughtful submissions received, reflecting the enthusiasm and buy-in to the Cordatus ESG agenda from the team.

The clear winner however of the prize for 2021 was Andrew who once again demonstrated a wide range and varied set of initiatives across various properties.

Andrew is also applying his interest in ESG to the home environment and is in the process of installing an air source heat pump to his house.

Well done Andrew. A £100 John Lewis voucher is yours!

New Acquisition – B&Q, Elgin

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On behalf of a private client, Cordatus Real Estate is pleased to report the purchase of the B&Q in Elgin, Scotland for a price of c£7m.

The 44,850sq.ft store forms part of the busy Springfield Road Retail Park area in the town and is let to B&Q for a further 10 years.

Mike Channing, CEO of Cordatus commented: “We are very pleased to have concluded this purchase. Our client has an appetite for well-located properties let to strong covenants and this asset fitted that requirement perfectly.

We are looking for further investment opportunities like this for them”.

For further information please contact Mike Channing or Neil Tweedie.

Economic and Market Commentary Q3 2021

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Brexit news

Now that Brexit is a reality, it is becoming increasingly difficult to determine whether specific aspects of the economy are reacting to ‘Brexit effects’ or merely reacting to the more global effect that is coronavirus. Consequently, we have decided to retire this section after more than five years.

Any impact to the UK or other economies on what could be considered a Brexit factor in the future will certainly be included in future reports in the section to which it relates.

However, we do mention in closing the prospect of the UK-EU trade deal being threatened over the UK threatening to trigger Article 16, fundamentally rewriting the protocol on Northern Ireland. What would politicians do without disagreements?

Global economy

The pandemic continues to cast a dark shadow over global economies. Following strong growth in the middle part of 2021 when many governments successfully eased lockdown restraints and which in turn fuelled a significant recovery in economic activity, momentum has weakened over recent months.

Transmission of the delta variant of the virus has not slowed down and its negative effects on global supply chains have become all too evident. Supply disruptions have increased and this in turn has led to higher inflation, reaching levels in some countries not seen in four decades.

Our global growth forecast for 2021 has been trimmed by 10 basis points (bps) from our most recent (August) report to 5.9% with the next year’s forecast remaining unchanged at 4.9%. These broadly maintained high level figures mask some significant differences in country performance: large 2021 downgrades for the US (down 1.0% from our last report), Germany and Spain (0.5%) and ASEAN countries (1.4%) and large upgrades for South Africa (up 1.0% from the last report), Italy (0.9%) and France (0.5%). It is noticeable that for many of these nations, upgrades for 2021 are followed by reductions in 2022 while the opposite often occurs for those having been downgraded this year.

Not all countries are recovering to the same extent. The differing country performances are starkly shown by the fact that aggregate output for the advanced economy group is anticipated to regain its pre-pandemic trend path next year (and to exceed it in 2024 by 0.9%) whereas that for the emerging market and developing economy group (ex-China) are expected to be 5.5% below the pre-pandemic forecast in 2024.

Much of this two-speed recovery can be attributed to the levels of access to vaccination: around 60% of the population of the advanced economies are fully vaccinated (and some are receiving their third, or booster, jabs), while only about 4% of the population of low-income countries have been vaccinated. The noticeable increase in Covid infections currently being seen in many countries also places doubt on the ability of countries to maintain current rates of economic growth with some countries edging towards renewed restrictions including the possibility of new lockdowns. Just when we thought that the vaccination programmes were winning the battle against Covid, we are having to accept that Covid-19 has not gone away and may be with us for some time yet.

Supply disruptions are another concern to many countries. This has resulted in shortages of key materials. Coupled with pent-up consumer demand and increases in commodity prices, inflation has begun to rise particularly rapidly, giving central bankers challenges they have not faced for many years. While some central banks are playing down the length and severity of future inflation, others, including the Bank of England, fear that higher inflation may be with us for longer and that the peak in inflation may well be higher than many foresee.

After a couple of quarters of above trend growth for many countries, third quarter GDP from across the globe showed much slower growth. Supply chain bottlenecks were cited by many countries as a key reason for the slowdown, as was the impact of much higher rates of inflation. The US were first to announce their economic growth in Q3: 0.5% growth against 1.6% in Q2. The euro-area and the UK posted higher growth rates, even if both were hampered by supply chain problems.

All-in-all, risks to economic prospects have increased and are tilted to the downside.

Inflation, interest rates and commercial property

There are concerns that the great moderation, the lengthy period during which business cyclicality and inflation both reduced, has not just come to an end, but is in the process of reversing. Inflation rates are increasing right across the globe, in some cases, to levels not seen since the turbulent 1970s. Some central bankers believe that these higher rates of inflation will be short-lived: others, including the Governor of the Bank of England, are less bullish and believe that inflation will be higher for a much longer spell than most are predicting. Certainly, there are daily indications of firms raising prices and commentators widely expect UK CPI to rise further from today’s 3.1% – maybe to as much as 5% – in the coming months, which would be the highest in a decade.

In anticipation of a rise in base rates, which the market now expects within the next three months, UK government bond (gilt) yields have been edging higher, the 10-year gross redemption yield having doubled (to 1.2%) over the last few months. A hike in the Bank’s base rate is inevitable although the market was wrongfooted earlier this month when the Bank opted to take no action at that time. Expectations are for the Bank to raise rates in early 2022. Higher costs of money and rising bond yields do affect investors’ views on all assets by making them less attractive relative to gilts. But will this (relatively) small uptick in the bond yield actually affect sentiment to commercial property?

Historically, higher inflation was often accompanied by higher rental growth. That will be much less of a feature today. Apart from parts of the industrial market, tenant demand is just not there to push rents higher: additionally, leases are typically much shorter nowadays, so that fewer tenancies actually extend past the first rent review date.

The second indirect impact higher bond yields have on commercial property is that they also tend to precede higher property yields. So, will a higher interest rate environment mean that property yields will increase as well?

The short answer is yes, but we remain relaxed on that possibility as we believe that the Bank will steer a very gradual course with the base rate still at or below 1% by the end of next year. In these circumstances, property yields should be unfazed by that small increase, certainly at the prime end, although more secondary assets or properties in less desirable locations with break clauses or lease expiries may see some upward pressure on yields. As one agent put it, “there will be a big difference between the best and the rest”.

The EU economy

The EU moved out of recession in Q2 with growth of 2.1% following two quarters of contraction but any hopes that it would build on this positive momentum were hindered by the ongoing battles with the virus and supply chain problems which were particularly damaging to big manufacturing countries such as Germany. Even so, the first estimate of Q3 growth of 2.0% was in line with expectations.

As in previous quarters, economic growth rates differed markedly by country. Austria (with growth of 3.3% in Q3) and Portugal (2.9%) have managed to sustain above average growth rates in both the last two quarters in contrast to Germany whose fortunes have been sorely tested by the marked slowdown in global trade and which posted growth of 1.8% in Q3 after another below average growth of 1.9% in the previous quarter.

Despite these headwinds, our forecasts have increased for 2021 by 40 bps to 5.0% while next year’s expectation remains unchanged at 4.3%. France and Italy, both of which enjoyed a strong economic bounce in Q3 with growth of 4.0% and 2.6% respectively, were the main drivers of 2021’s upgrade. Supply chain issues have particularly affected Germany, lowering our 2021 forecast by 50 bps. However, these problems are anticipated to be temporary and recouped next year, resulting in the 2022 forecast being increased by the same amount.

There was better news about unemployment in September which fell for the seventh consecutive month to 6.7%. It has now fallen by 1 percentage point since it peaked last summer at 7.7% but it remains well above the position pre-pandemic when the unemployment rate was 6.3% and it will be some months yet, and only with a fair wind, before that landmark is reached.

As with our forecasts for the other economies, the risks to the euro area economy are skewed to the downside and are vulnerable to a renewed spread of the virus.

The UK economy

Rising inflation, growing unemployment, rocketing government spending and borrowing, increasing taxes, high energy prices and shortages of goods. That is all very reminiscent of the grim period of the early- to mid-1970s. For UK citizens with long enough memories, a period which culminated in the UK having to go cap-in-hand to the IMF for a £3.9bn bailout and which then ushered in the lengthy rule of Margaret Thatcher.

But these economic factors are not just back in the UK, they are also present in many other countries. The pandemic may be being tamed, although that is still debatable, but its legacy of high government debt with its repayment issues, increased unemployment, supply chain problems and high inflation is gripping much of the global economy.

Who would have believed that Germany, the model of fiscal prudence, could see annual inflation of over 4½%? Who would have considered that after decades of moderating influences for inflation, in particular globalisation, it would so quickly unwind and create inflationary pressures? And who would have contemplated the fault lines in global trade caused by major delays to supply chains?

All these aspects are in addition to the financial, social and political impacts that the pandemic continues to create, almost two years since its discovery at a Chinese ‘wet market’. Add to that the continued uncertainties surrounding the country post-Brexit, it is then clear that policymakers have a lot on their plates.

The short, sharp downward jolt to activity around the world followed by an equally rapid recovery that was promulgated in early 2020 now seems an age away. The successful roll-outs of vaccines has slowed the transmission rates, reduced the mortality rate of those infected and enabled much of the world to ‘get back to normal’ but challenges remain: virus transmission rates still remain high in many countries, forced isolation following close-contact is still prevalent while disruption to supply chains is a world-wide phenomenon, made worse by the pandemic, and not just one encountered in the UK following Brexit.

The recovery in the UK is slowing down – similar to that of many other countries – but at least activity in Q1 and Q2 has been revised up in recent statistics. The magnitude of the Q1 contraction initially announced has been reduced from 1.6% to 1.5% while growth in Q2 has been upped from 4.8% to 5.5%. However, the slowdown evident since the summer limited further recovery to growth of just 1.3% in Q3, according to first estimates. This has prompted a slight downward 20 bp revision in our expectation for 2021 to 6.8% with a compensating 20 bp upward revision to the 2022 forecast. Risks to our forecasts remain tilted to the downside. This Q3 figure indicates that the economy is still 2.1% below pre-pandemic levels (although the gap is narrower when using monthly data).

Of major interest for policymakers has been how much the economy has been ‘scarred’ by the pandemic – i.e. the damage done to the economy that is not recoverable in the future. In the November Budget, the Office of Budget Responsibility cut its scarring assumption for the UK economy from 3% to 2%. The Bank of England is even more optimistic at just 1%. Putting that into perspective, the scarring caused by the global financial crash is estimated to have resulted in a 10% permanent loss of output in the UK. The current scarring brought about by Covid crisis therefore may be seen merely as a footnote in future assessments of the economy. But that is not necessarily the view just now with the economy still struggling to regain momentum after the summer bounce and autumn slowdown.

Inflation has re-emerged as a key concern. We have commented earlier on the impact that inflation is having at the global level and the UK is not alone in witnessing inflation at levels rarely seen in the last three decades. Already more than one percentage point above the Bank of England’s 2% target, commentators are suggesting that the UK’s CPI could approach 5% by spring 2022 before edging back. The Governor of the Bank has indicated that the Monetary Policy Committee (MPC) will act sooner rather than later in trying to curb future increases. But markets were spooked when rates remained at 0.1% at the November meeting of the MPC after which February 2022 became the new favoured month for the first rate rise in three and a half years. The impact on property performance of any increases in interest rates has already been discussed and is further developed in the next section.

October saw the end of furlough. It was an unqualified success, limiting the rise in unemployment which otherwise would have resulted. By the end of the Coronavirus Job Retention Scheme, there were still 1 million workers still on the government’s payroll – the question is what is the future for these workers? It has been widely reported that there are presently over a million job vacancies across all industry – but those unemployed do not necessarily have the required skills, nor are they in the right location to fill these vacancies– witness the need to encourage overseas drivers to come to the UK on temporary visas. However, given the monumental hit to the economy last year, the fact that unemployment has only risen by 50 bps since March 2020 to 4% shows the success of the furlough scheme.

But that success has come at a cost with the government now wrestling with how to finance this largesse. Already, national insurance increases have been announced, purportedly for financing the rise in the social care budget, VAT rates for hospitality are on the way back up and further tax rises will certainly be needed. As before, the government faces the dilemma of when to do so – too soon and it could choke recovery; too late risks even higher inflation. The thorny prospect of whether to again break an election pledge not to raise taxes is one more issue that the government needs to ponder.

Despite the success of the UK’s vaccination programme, Covid transmission rates remain stubbornly high. So too does the number of Covid-related deaths. Consequently, the UK has been and continues to be more vulnerable than many other countries to disruption to its activities. Although currently far from the government’s thoughts, a re-introduction of restrictions or even another lockdown cannot be ruled out.

Market Commentary

With recovering investment activity and improving levels of occupier interest and take up, Q3 was sizing up to be a particularly strong quarter in terms of performance. And so it turned out. In many ways, the 3.0% average capital growth at the all property level and the 4.1% total return was exceptional given the many and large headwinds the industry has been facing in the last few quarters. The quarter’s performance was the best in seven years and the 11th best quarter’s return in the near 21-year history of the MSCI (IPD) Quarterly Index.

The key drivers to this strong performance were further inward yield shifts across most property segments and the continued stand-out performance of industrial assets. Even the hard-pressed retail sector as a whole posted positive capital growth in the quarter with retail warehouses seeing particularly strong growth. Average values increased there by 5.4% in the quarter, which builds on the previous quarter’s 2.0% increase.

For 2021 to date, all property total returns have totalled 9.6%. The current slowdown in the recovery of the economy would normally suggest caution on future quarterly returns but current sentiment to and momentum in the commercial property market would suggest that Q4 may also be a strong quarter, if not quite at the scale of Q3. But the immediate path of the economy is not the only headwind to future performance. Arguably of greater concern is the ever-more certainty of interest rate hikes. A slowing economy coupled with rises in the cost of money is rarely good news for property investors.

Commercial property has benefited from the recent period of ultra-low interest rates. All property yields are now declining, reversing the long upward yield trajectory. At a time when rental growth outside the industrial sector has been hard to find, the downward yield shift has been the major contributor to the market performance. MSCI’s Monthly Property Index (which is not as representative of the market as the much larger Quarterly Index) indicates that the yield shift in the month of September alone (which added 1.5 percentage points (pps) to total returns) was the largest single month’s contribution for almost eight years. The Quarterly Index concurred with this feature: yield shift in Q3 added 2.5 pps to the all property total returns. For once, it was not just the industrial sector that was the main beneficiary of this downward yield shift: it added no less than 5.8 pps to retail warehouse5s’ total return in the quarter.

According to the Quarterly Index, over the last 12 months (from the start of yields hardening at the all property level, the yield impact factor alone has added 6 pps to capital returns while the yield impact on the industrial sector has added an astonishing 17 pps in that period. As the all property capital growth over these four quarters amounted to the same 6%, one can readily see how much property performance has been driven by the inward yield movement. For the industrial sector, capital returns amounted to 22% over that period, again highlighting the importance of yield shift to overall performance.

Clearly, these downward yield movements are unsustainable going forward, even if the economy were firing on all cylinders. But it is not, and with gilt yields already on the way up, it would be unrealistic to expect property yields not to do the same. That said, we do not anticipate property yields will rise materially any time soon and we are of the opinion that any base rate increases will be moderate: we expect the Bank of England’s base rate to be at or below 1% at the end of next year, which should therefore limit any increase in property yields. Outperformance during a period of rising property yields would require rental growth and bar for the industrial sector, and perhaps the retail warehouse sector, there are few parts of the market with that prospect over the near term. The one caveat to our mildly encouraging view that any upward property yield movement will be limited and delayed is that in this more connected investment landscape, once the market senses a change of sentiment, yields can and do move very quickly.

In terms of performance, there has been a notable shift in emphasis over the last couple of quarters. Industrial assets have delivered the best total returns of all the main sectors for 23 consecutive quarters – almost six years – a record that shows no sign of ending. Retail had been the weakest sector by far until Q2 2021 when it overtook the office sector in total returns. No-one can suggest that all retail’s problems are in the past but investors, at least, are taking the view that the parts of the sector are beginning to offer better value. Rental growth remains illusory still but yield compression has been a feature of the retail sector now for nine months. At the sector level, all retail equivalent yields have fallen by 42 bps over 2021 to date, partly reversing a rise of 130 bps (over 1¼%) over the previous three years. That yield compression is due to the weight of money chasing retail assets.

Investment volumes for the market as a whole continue to rise. Although September recorded a slightly lower volume of deals than in the previous month, the year-to-date figure of approaching £40bn is not just above that of the equivalent figures for 2019 and 2020, it is in line with the five-year average.

Again highlighting the improved sentiment towards the sector, monthly retail transactions hit a year’s high in September. Deals in that month alone reached £755m, 38% above the five-year monthly average. Not only were retail warehouses in demand, there has been a welcome improvement in investor interest in shopping centres and supermarkets. Shopping centre deals remain well below the pre-pandemic norms, but investors are viewing supermarkets as one of the must have segments. Retail warehouses, too, are currently back in favour with investors

The sustained investor 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. Commercial property outperforming equities and bonds over such a long period is unusual and it would be a brave investor who believes that will happen over the coming 10 years. Also note the recent strong performance of property equities (REITs) which is often a leading indicator of the performance of direct property.

The 10-year property total returns of 7.1% pa are attributable mostly to income returns and yield compression, which together accounted for 96% of these returns – the balance being from rental growth, predominantly from industrial assets. Almost three-quarters (72%) has derived from income returns and just 2 percentage points pa has come from capital growth and of that yield compression has been by far the most significant factor. Yield movement has been even more marked in returns over the last three years.

Over the last 20 years, the average annual total return of 7.1% (coincidently the same as for the 10-year performance) has comprised 5.6% for income and 1.4% from capital. However, in another warning over the sustainability of the current returns, the income return over Q3, at 1.09%, is the lowest in the Quarterly Index’s history. Even lower than during the run-up to the global financial crash.

Far from being pushed down the financial agenda during the challenging times most businesses have been facing, ESG (environment, social and governance) issues have actually become more important for many. There are many facets to this topic. One key aspect is that many tenants’ occupational requirements are now demanding ‘greener’ properties, whether that be in their construction or in having a lower carbon footprint. It is too early to postulate, but it will be interesting to see in the future, not if there is a ‘green premium’ to such properties, but how big the premium becomes.

The industrial sector

The sector continues to deliver remarkable rates of return. Average capital growth of industrial assets of 6.45% in the quarter gives rise to a 12-month sector growth of 24%. Not once before in the history of the Quarterly Index has an annual rate of capital growth of any sector been this high.

It is not difficult to comprehend the reasons behind this phenomenal rate of growth, which we have highlighted in previous reports: the pandemic-induced switch from physical shopping to online with strategically placed distribution hubs being key to the success of the growth of the online model. Take up of industrial space hit a record high in 2020 at almost 50m sq ft (Source: Colliers Data Bites October 2021) and with 44m sq ft already let, this year seems set to exceed that total.

This increase in take up, having doubled in the last decade is directly affected by the increase in online sales over that period.

Online sales have been growing for years, but this means of sales received a further boost last year during the periods of lockdown. Clearly the rate of growth in online sales will slow from the breakneck speed seen over the last 18 months, but online sales are here to stay.

Considering only the large (100,000 sq ft) + units, Q3 take-up topped 11m sq ft, resulting in a year-to-date figure of 33m sq ft. Although down 11% from last year’s record level, this is still the second strongest Q1-Q3 figure on record. Demand for grade A space has dominated so far this year, but there has also been a major uptick for take-up of speculatively developed units. This is driven by a lack of available space and occupiers’ need to quickly fulfil their requirements. Current supply at the end of September stood at roughly 20m sq ft, the lowest ever seen in the sector and a decline of 38% compared to a year ago. An ongoing lack of supply may hamper future activity and pre-lets are likely to become even more prevalent to satisfy occupier requirements.

There is one crucial risk factor that one has to bear in mind with distribution warehouses. There has been a huge increase in the number of these built and occupied over the last couple of years. Some will be occupied on the back of (largely) one key contract won with a supermarket chain, for example. That contract will be for a specified number of years and there is no guarantee that the contract with that company will be extended, highlighting the potential risk of these units falling empty at the end of the contract.

The retail sector

It is rarely that one can has been able to paint a positive picture on the beleaguered retail sector but, ever so slowly, both investment and just as importantly tenant demand seem to be heading in an upward direction.

Average shop values are now rising for the first time in over three years while even the hard-pressed shopping centre segment saw the decline in average values fall to a tiny 1% in Q3 – a welcome change after values have more than halved over the last six years.

Retail warehouses stand out, however, in what has been, until recently, a tide of red. Buoyed by some consumers’ preference to visit retail parks rather than face shopping in indoor malls or crowded high streets, these units have seen some spectacular growth over the last six months. Average retail warehouse capital values have risen 7.5% over the last six months. This increase is purely yield driven: rental values are static while the equivalent yield has hardened by a significant 68 bps to 6.8% over that timescale. The table below indicates that CBRE believe that there is further downward yield shift to come.

Shop yields, too, have started to edge lower this year. Despite rents still drifting lower, this yield shift was enough to ensure that average shop values increased over Q3. Of concern here, though, is the continual increase in shop vacancies. More than one in eight shops are vacant in central London while the vacancy rate nationwide is now over 10%. Landlords and local authorities will have to do some serious thinking if the high street is ever to return to its vibrant past.

The one retail segment that has not yet seen average values rising is shopping centres. Vacancy rates are rising here as well while rents are still heading south but the 0.8% fall in Q3 was the lowest quarterly decline in 3½ years.

While the outlook for the retail sector remains challenging, there are clear signs that investors are now starting to reconsider the sector as offering better value. Shopping centres, however, are certainly not in that category, yet.

One example of the way the high street is adapting to changing customer habits is Ikea’s purchase in October of the former Top Shop building on Oxford Street, London for £378m. Amounting to 239,000 sq ft of office and retail accommodation, the seven-storey store will be the furniture giant’s first UK city centre store, following openings in New York, Tokyo and Madrid. Several more are in the pipeline. It is due to open in 2023 and will focus on home-furnishing accessories, with the full range available to buy for home delivery.

The office sector

Take up across the UK increased to 1.3m ft over Q3 adding to the 2m sq ft take up over the first half of the year. This total take up in the first nine months of the year was just two-thirds of the average level of take up over the last five years but it is an improvement on the position at the end of June. The business services sector was the most active occupier during Q3, accounting for a quarter of all space let, but the biggest letting in Q3 was the 75,000 sq ft office at Buchanan Wharf, Glasgow which was let to The Student Loans company.

Including investment transactions in central London (which is covered in the next section), deals across the UK for the first nine months of the year totalled £11.1bn (Source: Colliers Property Snapshot, October), well up on last year’s Q1-Q3 £8.1bn. September was also the fifth month in a row than investment exceeded £1bn.

The regional office market has been much stronger than that of the south east. Rents have been growing for eight successive quarters and rental growth over 2021 to date is a fairly respectable 3.1%. However, vacancies are rising here too but at 12.5%, the vacancy rate of the regional office market is well below that of the south east where more than one in six offices now lie empty.

Central London offices

As business returns to some sort of normality, so too are occupiers re-activating their office requirements.

Third quarter take up in both central London sub-markets recorded the largest quarterly figures since the onset of the pandemic although data from the West End was significantly stronger than that from the City. For the former, take up in September was the highest monthly figure since 2019, helping Q3 to record the highest quarterly take up for three years. The City data, in contrast, was much weaker: September’s take up, at just 136,000 sq ft, was the lowest monthly figure this year, taking Q3 to just over 1m sq ft, up on last year’s equivalent figure but still the second lowest in the last decade.

In addition to renewed take up activity, the amount of space under offer is significantly higher than in the past. A total of 3.6m sq ft of office space is currently under offer in central London, noticeably higher than the long-term averages in both sub-markets. Adding to these positive statistics, active requirements currently exceed 10m sq ft. This all indicates that take up in Q4 and into 2022 will remain strong.

Meanwhile investment transactions seem to be returning to pre-pandemic levels. Still the focus of many income seekers, commercial property fits the bill while large, central London offices, also being relatively liquid, have been particularly sought after. Over £4bn of London office deals were recorded in the third quarter of the year meaning that £8.7bn has been transacted this year, double the amount of the equivalent nine months last year.

The City market has been noticeably busier. As well as deals worth £2.34bn being concluded in Q3, there are currently 18 other properties, valued at £2.15bn, under offer with a further 62 others being openly marketed. Already, transactions this year have exceeded the value transacted over the whole of 2020 and it seems likely that the total amount of deals that will conclude this year could nudge the 10-year average of £9.5bn.

While the volume of deals in the West End is somewhat less than that for the City, Q3 transactions of £1.76bn exceeded the value transacted during preceding six months of the year. As with its eastern neighbour, there has been a flurry of openly marketed properties over the summer with a further 25 with a value of £1.23bn having been launched on the market during September and early October. Q4, traditionally the strongest quarter for deals, looks likely to build on the momentum of Q3.

It is necessary to highlight the marked rise in available space. The West End manged to buck the rising trend in Q3 but even so, the vacancy rate there of 6.7% is well above levels recorded in the recent past. But it is the City office market which is beginning to pose real problems. A further jump of 30 bps to 9.3% has moved the City’s vacancy rate 2.8 percentage points higher than it was a year previously.

These statistics are estimates from Savills, but data from MSCI paints an even gloomier picture. Q3 data shows that the vacancy rate of City offices has reached a 12-year high at 16.5% while the West End has increased to a three year high. It is necessary to point out that the agent’s figures may be a truer guide to the actual position as not all properties feature in the MSCI performance measurement statistics. Irrespective of whichever measure paints the more accurate picture, it is clear that the current level of vacant properties is sure to increase in the coming quarters as developments come on stream and take up remains relatively muted.

Currently, there is a total of almost 21m sq ft space available in the two markets (13m sq ft in the City and 7.8m sq ft in the West End). It is estimated that over the coming four years, a total of 27.3m sq ft of new developments will be completed in central London (15m in the City and 12m in the West End). Of that total, only 3m sq ft has been pre-let implying that, on current build estimates, over 24m sq ft of office space will be completed speculatively. That is a lot of potential space to let, leading to even higher than current vacancy levels and limited rental growth – if any. As mentioned in previous reports, delays caused by worker and material shortage may be one saving grace from the pandemic effects, thereby reducing the actual amount of space completed.

MSCI statistics show that rents in both sub markets have been flat over the course of the year. Agents’ data point to a more bullish outcome with average Grade A rents up since the start of the year by £2 per sq ft (psf) in the City and by £7 psf in the West End to £67 and £82 respectively. Grade B space has also seen growth in both markets this year.

However, as with other segments of the property market, yield compression rather than rental movements was the driver of capital growth in Q3. MSCI revealed that City yields moved in by 10 bps (from 5.26% to 5.16%) and West End yields by 2 bps (from 4.6% to 4.58%). Bar for a brief spell in 2018, City yields have never been that low since March 2007 – just before the GFC.

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 2021

CPT Awarded Green Star Rating

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Cordatus Property Trust has been awarded a Green Star in the recently released GRESB 2021 survey results.

Mike Channing, CEO of Cordatus Real Estate and Fund Manager of Cordatus Property Trust commented “this is a very pleasing result. A significant amount of hard work has gone into improving the ESG credentials of both Cordatus Real Estate and Cordatus Property Trust and it is good to have this hard work recognised by the industry’s benchmark survey.”

The Cordatus Property Trust was established in December 2015 and has consistently outperformed its MSCI benchmark over that period. In the 5 years to June 2021, the fund delivered an unlevered 7.0%pa total return (MSCI Quarterly Index 4.3%pa) and an income return of 6.4%pa (MSCI 4.5%pa), ranking the Trust on the 3rd percentile for income.

Continuing focus on ESG initiatives

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We have been busy across the Cordatus Property Trust portfolio completing a number of ESG initiatives in 2020, but our work is never complete with a focus on ongoing projects for 2021.  A couple of examples of the work completed last year are:

33 Bothwell Street, Glasgow

The 2nd floor vacant office suite was stripped back to shell condition and the gas-fired wet panel heating system was removed. The refurbishment works included the installation of a new ceiling system, with LED lighting and PIR motion sensors, plus a new 7 zone, 2 pipe VRF heating and cooling system.  On completion of the works, the accommodation received an EPC rating B.

The reception area of the building was also upgraded. Works included the replacement of the reception desk and furniture, new flooring and wall coverings. Lights were replaced with new LED lighting.

  Minster Court, Littlehampton

We took back an industrial unit totalling 3,200 sqft, which had been heavily fitted out as a food processing unit. We undertook strip out and refurbishment works, in order to bring the unit up to a lettable standard. The works included the removal of two cold storage units, a mezzanine structure, three industrial cookers and a thorough overhaul of the electrical system and services throughout.

The project presented an opportunity to review the unit’s ESG credentials and upgrade accordingly. We were able to replace the existing lighting with LEDs, plus the removal of an old inefficient boiler with a new electric flue boiler designed to heat re-circulated water within the heating system therefore recycling water and reducing waste.

2021 ESG Initiatives Underway

In 2020 we completed a BREEAM In-Use assessment of Queen Square House, Bristol. The assessment resulted in an Acceptable rating, will boost the fund’s GRESB score in 2021 and will be used to inform the ESG performance of the asset going forward. To assist with this a BREEAM In-Use Improvement Plan has been produced and will be reviewed to identify appropriate actions that can be implemented in the coming years.

We are also reviewing the energy performance of the whole portfolio. One element of this is updating and improving the EPC ratings on all units and taking a risk based approach to EPC improvement. A second element of our energy performance review is targeted energy audits at our assets with the highest energy consumption. The first asset we are targeting for an energy audit is the Lisnagelvin Shopping Centre in Londonderry. An initial desk-based assessment has been completed and an on-site audit will be undertaken once Covid restrictions are lifted.

Another key priority is to fully understand the Taskforce on Climate related Financial Disclosure (TCFD) recommendations and how they apply to the portfolio and assets so that the portfolio is resilient to climate related risks. As part of this we are considering different options for the assessment of physical and transition risks. This will include making use of the Carbon Risk Real Estate Monitor (CRREM) tool to assess the transition risks associated with assets for which we have data.

Second Annual Cordatus ESG Award

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We are delighted to confirm that the winner of this year’s Cordatus ESG Award is Andrew Murray.

The award encourages the Cordatus team to continually think about these important issues as part of the day to day portfolio management of their assets. This year there were a record number of submissions, all of which were of high quality.

After careful deliberation, the judging panel felt that Andrew’s submission however demonstrated a clear understanding of not just the importance of the ‘E’ of ESG in the real estate sector but also the ‘S’ and a range of successful initiatives were recorded across a wide range of property types and locations.

Andrew commented:

“I am delighted to be awarded this accolade for the second year running and I would like to think of this is a team effort alongside our property managers and consultants, as we continually strive to improve the ESG credentials of our assets under management. Whilst last year had the additional complications from COVID-19, we were still able to implement a wide range of ESG improvements across our assets both from refurbishments as well as through a number of community creativities, such as offering NHS key workers discounts and priority queuing at our neighbourhood centres. We also have some very interesting ideas for the year ahead, including the potential introduction of bee hives and bug hotels at some of our industrial estates.”

An Amazon e-voucher of £100 was awarded to the winner.

Harrow auction success

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Despite views from some that the high street investment market is uniformly difficult we demonstrated in a recent auction that there is strong demand in certain micro markets.

As part of a rebalancing exercise Cordatus Property Trust has sold 82-84 St Anns Road, Harrow for £3.25m , some 75% above the guide price. The lot was the largest in the Acuitus auction and attracted intense bidding from a large number of private investors. The price achieved reflected the demand for retail units with accompanying residential development potential in a market that has been largely starved of opportunities.

The sale reflects our policy of always employing a bottom up as well as a top down strategy when it comes to both purchases and sales.

Economic and Market Commentary Q1 2021

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Brexit news

The post-Brexit Trade and Co-operation Agreement between the UK and the EU, which had been operating provisionally since January, was formally ratified by the European Parliament at the end of April.  MEPs voted overwhelmingly for the trade deal by 660 votes to 5.

The agreement now comes into force despite reservations on both sides about fishing rights and the difficulties over Northern Ireland trade. The first of, no doubt, several stand offs occurred just a few days after the Agreement’s ratification, resulting in warships being deployed to protect the Jersey fishing fleet. Ironic, as Jersey is neither part of the UK nor in the EU, but is a Crown dependency so is defended and represented internationally by the UK government. Gunboat diplomacy at its most basic!

A reminder that the trade deal covers the trade in goods only and we await any news on future trade between the two on the likes of financial services.

Meanwhile trade between the two recovered in February after the significant drop the month before. UK exports to the EU jumped by 46% in February after January’s 42% fall. It does, though, mean than exports are still down roughly 15% over the first two months of the year. While some of the reduction in trade was down to added bureaucracy, many companies were bringing forward business ahead of the implementation of the new rules, thereby increasing trade in late 2020 at the expense of trade in the early months of this year.

The UK and India have announced a new, enhanced trade deal between the two countries, with the aim of doubling trade by 2030. And hopes of a deal with the US have risen with the American Secretary of State, Antony Blinken, suggesting that the dialogue between the countries could be revived.

Global economy

It is now just over a year since the World Health Organization declared Covid-19 a global pandemic. Many lives have been lost, economies shattered and billions spent on protecting jobs and businesses but much, too, has been achieved in the last 13 months, none more so than the rollout of several vaccines at record pace. However, many hurdles and uncertainties remain.

Infection rates and mortality rates are still stubbornly high in many countries and vaccination programmes are not progressing as quickly as desired in some countries. Yet there is much reason for optimism about the near term.

The vaccination programmes should lower future infection rates. Economies, businesses and individuals have adapted remarkably well to the constraints imposed while the massive fiscal support that many countries have employed, and are still doing, brings a more positive feel for economic activity.

We are now forecasting a stronger recovery this year and next for the global economy compared to our forecast three months ago, although the upgrade is substantially brought about by the better growth prospects for the US. We are now expecting world growth to be 6% this year and 4.4% next year, an increase of 80 and 50 basis points respectively from the January forecast.

Forecasts for the US have increased significantly since our previous report. Our expectation for growth this year has been hiked from an already strong 5.1% to our present 6.4%. Next year’s forecast has been upped by one percentage point to 3.5%.

Much of these increases are on the passing of the ‘American Recovery Plan’ act. The £1.9tr package is one the largest in US history and includes $1,400 payments to every US citizen, an extension of unemployment benefits and a child tax credit. It is estimated that this stimulus is in itself responsible for adding one percentage point to expected global growth over 2021 and 2022 combined.

Not content with seeing through the Recovery Plan, President Biden is now proposing an even bigger $2.3tr package to upgrade the country’s aged infrastructure and in tacking climate change. It is likely that will be financed through raising corporate taxes and increasing public spending and these features alone will alienate Republicans. The Democrats are divided over the magnitude of the proposals so Biden will have his work cut out to ensure this policy is passed.

It is evident that the pace of recovery is differing significantly not just across countries but also within countries. Much of these divergences can be linked to the varying pace of vaccination, although the extent of economic policy support and other structural factors (most noticeably, countries depending on tourism) are relevant. Already China has surpassed its pre-Covid level of GDP, the US is now forecast to do so later this year, but many others may take up to another two to three years to regain their pre Covid levels of activity.

Of increasing concern is the probable return of inflation. Already energy prices are increasing (oil prices have trebled over the course of the last twelve months), commodity prices are rising and while there is no prospect of inflation increasing anywhere near levels seen in the 1970s and 1980s, rates moving above the 2% levels central bankers have been targeting are likely. Some US investors are already putting money into inflation-linked government bonds, a sure sign of their concerns over the re-awakening of inflation.

The EU economy

In contrast to the booming US economy, the eurozone’s economy fell back into recession in Q1, 2021. An overall 0.6% shrinkage in the latest, January to March, quarter followed the 0.7% reduction in Q4. These last two quarters’ contractions marked the second such recession for the eurozone (defined as two successive quarterly declines in GDP) since the onset of the pandemic.

The first quarter’s data has clearly been affected by the renewed surge of Covid-19 infections and the resultant restrictions imposed but it is also evident that different countries have been experiencing differing levels of, and timings of both rising infections and tighter restrictions. To date, only Italy of the larger continental economies has plunged into recession this time, having contracted in both the last two quarters. France, Germany and Spain have managed to post growth in one or other of the last two quarters.

Germany was the most affected large economy in Q1 with a 1.7% contraction. A hike in value added tax in January following a temporary cut last year to support the economy was a key contributing factor in the decline.

Much of the pessimism about the near-term performance of the economy across continental Europe relates to the slow roll out of the vaccination programme. At the date of publishing this report, vaccines have been administered to approximately 30% of the EU population, compared to 46% in the US and 53% in the UK. Comparing the number of individuals who have received both doses, the EU (roughly 10%) trails the US (32%) and the UK (26%) (source: Johns Hopkins University).

Despite the job retention schemes that were introduced last year, unemployment increased over the summer of 2020. The unemployment rate for the euro-area peaked at 8.7% in August. It has fallen back to 8.1% or 13.2m unemployed. Over the course of the last twelve months, unemployment has increased in the euro-area by 1.6m.

The UK economy

The outlook for the UK looks brighter now than at any time during the Covid period. While activity has undoubtedly been affected by the most recent lockdown, businesses have adapted more effectively to the latest restrictions, thereby ensuring that the hit to the economy during the most recent lockdown is much less than during the initial one in Spring 2020. Then, the economy shrank by roughly 20%: contrast that with the first estimate of a 1.5% hit during the post-Christmas lockdown.

There are three main reasons for the improving confidence in the economy – the aforementioned business resilience, the rapidly improving rates of business and consumer confidence brought about by the rapid rollout and acceptance of the vaccination programme and the belief that UK consumers will soon be spending at least some of their accumulated cash savings. Continental Europeans must be looking enviously across the Channel at the speed of Britain’s vaccinations given their much discussed problems.

That is not to say that the UK is completely set fair. News that public sector borrowing hit £303bn for the year to March 2021 is a sobering reminder of the economic cost of the pandemic. That huge figure is almost £250bn higher than the total for the previous (pre-Covid) total and double that of the 2009/10 year at the height of the global financial crash. However, even that huge level of borrowing, equivalent to 14.5% of GDP, is still £24bn lower than the Office of Budget Responsibility had forecast just a few weeks earlier at the time of the Budget.

Consumer confidence hit a pandemic high in March while the re-opening of non-essential shops in April was eagerly anticipated by the frustrated shoppers. Additionally, a Deloitte survey showed that optimism amongst chief financial officers (CFOs) has risen to a record high. The same survey showed that CFOs have moved from defensive strategies to expansionary ones. Much of this optimism is down to the amount of savings the typical consumer has built up over the last twelve months. Many commentators believe that Britain is poised for a consumer boom. And judging by the lengthy queues pictured outside Primark, to name just one retailer, when it re-opened, few would bet against that expectation.

The UK’s GDP fared better than expected during Q4 2020, posting growth of 1.0% when most were anticipating contraction. The first estimate of a 1.5% contraction in Q1, encompassing a full three months of lockdown, was better than expected. And forecasts for Q2 and later are being upgraded almost daily. The IMF forecasts growth of 5.3% this year followed by 5.1% next. These have been increased by 80 and 10 bps respectively from last quarter’s report. More optimistic forecasts from Deloitte, Capital Economics and EY published in late April suggest that cumulative growth rates over this year and next could be up to 3 percentage points higher. The latter two named indicate that the UK will surpass its pre-Covid level of GDP in the second quarter of next year. As we go to print, the Bank of England has added to the good news by intimating that the UK is poised to grow by 7.25% this year, the fastest rate since comparable records began in 1949.

Further good news appeared with the news that the UK service sector, which accounts for over three-quarters of the UK economy, recorded its fastest rate of growth since October 2013 according to the widely respected IHS Markit/CIPS purchasing managers’ index for April. The latest monthly index of 61 was significantly above the previous month’s 56.3 and was the highest for over seven years. Tim Moore, economics director of IHS Markit welcomed the news, adding that the “April data illustrates that a surge in pent-up demand has started to flow through the UK economy, following the loosening of pandemic conditions”.

The feel-good factor has also manifested in a boom in house sales and house prices. House price growth usually moves in tandem with the economy; rarely do house prices rise during recessions, and if so, then not at the rate seen this year. Yet that is what has occurred. Over the last twelve months, average house prices increased by 8.2% (source: Halifax) while homeowners borrowed a record £12bn more than they repaid in April – the highest monthly amount borrowed in the 28 years that the Bank of England have been monitoring mortgage statistics. The pandemic may be responsible for some of this, with homeowners seeking to move to more appropriate houses but of equal importance are the low interest rates and the stamp duty holiday which has now been extended for home buyers in England, Wales and Northern Ireland.

Much of the optimism surrounding the UK economy is based on the expectation that, now the vaccination programme is progressing well and the government’s ‘roadmap’ out of the restrictions is seemingly on track, Britons will spend much of the savings they have accrued during the last twelve months or so. Survey data indicate that consumers have amassed between £150bn and £180bn since the start of the pandemic. Clearly not all will be spent – the Bank of England reports that consumers have been repaying non-mortgage debt in ever-increasing amounts – but retailers are eagerly awaiting a significant proportion of that being deployed to bolster retail spending.

Nevertheless, unemployment has been rising over the course of the last year, but at a somewhat lower pace than initially envisaged. At the onset of the pandemic, commentators were predicting that the unemployment rate would rise to 9%. To date, that figure looks particularly pessimistic, with 4.9% currently unemployed which is up from 4.0% prior to the pandemic. However, the test is still to come when the furlough scheme ends in September. Currently, there are 4.7m workers on furlough; not all businesses, particularly those in the hospitality industry, will emerge unscathed when restrictions are fully relaxed, and unemployment could take another lurch upward in the autumn.

The Commercial Property Market 

The commercial property market, as measured by the MSCI (IPD) Quarterly Index, returned to growth in Q1 2021 with a small but noteworthy increase in capital values of 0.64%. This quarter of growth therefore ended a nine-quarter decline in average property values, the longest in the 20-year history of the index.

But the fact that it was the All Property measure that returned to growth is only half the story. Once again, the industrial sector was the star performer with average values rising another 4.0% in the quarter. This advance was sufficient to carry the rest of the market as average office and retail valuations continue to fall. There was a noticeable reduction in the magnitude of the decline in average retail valuations – the Q1 decline of 1.51% being the lowest since Q3 2018 when retail values were just starting to decline.

And though it is tempting to believe that the worst is behind the commercial property market, and that, now the All Property valuations are moving up, future quarters will show further growth, that certainly cannot be guaranteed. Much will depend on how many businesses survive the coming months, particularly when the various job retention schemes and loans to businesses end in the autumn. Further bad news on the jobs front is certain over the course of 2021 and although the debate about the future of retailing and home working will be heard for some time, sentiment will sway with every major announcement.

Valuations of industrial assets continue to rise. The 4.0% increase in average valuations in Q1 took the last twelve-month increase to 9.3%, remarkable at a time of major economic challenge. The sector has clearly benefited from investors’ flight to safety, with logistics assets in particular being perceived as much safer investments than office or retail.

In contrast, average retail assets continue to see valuation declines. But the Q1 fall is the lowest since the third quarter of 2018. Within the retail sector, shopping centres continue to show extremely weak returns. A Q1 fall of 7.9% brought the twelve-month decline to over 28% and to a massive 55% since average valuations started their decline in 2016. There is better news about retail warehousing. A small 0.25% fall in Q1 brought the fall over the last year to a more modest 10%. Now that non-essential shops have re-opened, retail warehouses could be the retail segment where valuations are poised to recover first. Consumers, generally, remain reluctant to shop in crowded indoor malls, despite the safeguards put in place, whereas the outdoor setting of retail parks poses shoppers less issues. Add the segment’s link to house furnishings and DIY, these assets could well start performing.

While it is easy to believe that all forms of retail are suffering, supermarkets are clearly bucking the trend. An increase in average supermarket values of 1.9% took growth over the last twelve months to 5.5%. Not quite at the standard of industrial assets, but welcome nonetheless.

Tied in with the weak performance of retail assets is the continued shrinkage of the high street. The Local Data Company (LDC), which has been tracking shop openings and closures for some time, reported that 2020 was the worst year on record for closures – 17,532. And what made last year even worse was the fact that only 7,655 shops opened, the lowest number on record. Not surprisingly, the net shrinkage – the difference between the number which closed and which opened was a record high.

Emphasising how unusual last year was for retailers, city centres suffered the greatest number of closings (7.7% of the existing stock). London postcodes also fared badly with a closure rate of 6.9%. At the other end of the table, seaside towns and villages enjoyed the least number of shop closures, at 5.1% and 4.1% respectively. LDC note that this is a reversal of historical trends. For years, multiple operators have opened more sites in cities and closed units in smaller towns. As consumer and location preferences have changed over the course of the year, retailers are now preserving locations they regard having more potential in any post-pandemic environment.

Capital values across all office segments fell in Q1 but by less than 1%. This continues the robust performance of the office sector during the pandemic with average values having fallen by just 5% over the last twelve months. Perhaps surprisingly, central London offices, in particular City offices, are holding their values better than provincial ones.  Over Q1, the average values of City offices were trimmed by just 0.2% for an annual decline of 2.2%. Contrast that with the capital value performances of rest of south east and rest of UK offices which saw average declines of 0.6% and 0.8% in the quarter and 5.3% and 4.1% over the year.

In total return terms, commercial property delivered a positive return of 1.8% in the first quarter, pushing returns over the last twelve months into positive territory at 0.9%. Commercial property rarely performs during recessions, but as we have discussed before, this recession is like no other.

As can be seen in the next chart, property returns have more than held their own against other assets over the last 10 years.

Much of the reason behind commercial property’s solid returns is down to the restricted number of developments coming on stream and the huge quantitative easing programmes which have inflated real asset prices. Property has also benefited from ultra-low interest rates ensuring that the asset class delivers high levels of income, relative to other assets.

Sector issues


Long regarded as the third sector in terms of investment and investor interest, the recent outperformance of industrial assets and positivity surrounding the sector has well merited the reassessment it has undergone. Now the largest of the three sectors by some way – making up over 30% of the MSCI (IPD) Quarterly Index – it has certainly benefited from the pandemic-induced stay at home orders and shop closures.

Investment transactions hit a 20-year quarterly high in Q4 amounting to £5.6bn and the start of 2021 has also started strongly with transactions of £3.2bn, the third highest quarterly total in the last 20 years. At a time when investment in commercial property is down markedly, industrial’s investment in Q1 2021 is almost double that seen in the equivalent quarter of 2020.

This renewed demand for safe, solid income has pushed prime industrial yields down by 50 bps over the last twelve months, to 3.75%, remarkably half that of many prime retail assets. Pressure remains for further hardening of these prime industrial yields in the short term.


The key question critical to the future performance of offices is how the future use of offices will pan out. The work from home requirement has been more successful in terms of productivity than could have been imagined, but now, more than a year after the first lockdown, there are signs of workers suffering from ‘Zoom fatigue’, and many missing the company of colleagues. Many employees enjoy the greater flexibility that working from home offers: others would prefer to return to the office as their home has not proved suitable.

Many virtual board meetings will have discussed future working arrangements. There is, though, no unanimity in their deliberations. Two of the largest financial services companies, Goldman Sachs and JP Morgan have recently announced their future plans, and ensuring debate continues, they are taking different stances. On one side, Goldman has told staff to be prepared to return to the office in June. It also plans to open a new technology hub in Birmingham later this year. On the other side, JP Morgan has announced it intends to use “significantly” less office space in the future, requiring only 60 seats per 100 workers.

Irrespective of whether the Goldman or Morgan approach is the one favoured by the majority of businesses, what is clear is that work will definitely not revert back to the pre-Covid model. Surveys from several organisations have pointed to a desire by employees to a return to the office, but for just two or three days a week.

From an investment point of view, it is clear that investors will need to engage with tenants, and potential future tenants, in a way not required before. Flexibility will be the buzzword, landlords offering space that is flexible in terms of floorspace design, can be configured with all the necessary safety features, and even with greater flexibility in terms of lease length. Inserting more break clauses may not be what investors want but they may become a necessary feature for ensuring the space is let.


The performance of retail assets, on the whole, continues to disappoint. There are clearly a few bright spots, such as supermarkets and some supermarket-anchored retail parks, but for the majority of shops and shopping centres, valuations remain under downward pressure. A further 7.9% fall in average shopping centre valuations in Q1 brought the cumulative average fall over the last four years to 53%.  Investors have been reluctant to trade in this market – the few deals that have occurred recently have focussed on the potential for change of use – but there are signs that deal flow may be on the up and with a deepening pool of investors.  A test of the market will be potential sale of the Touchwood Shopping Centre in Solihull which is being marketed for £130m, an initial yield of 7.5%. A few years ago, its valuation was more than £400m.

The above valuation change calculations show only the impact of rising yields and take no account of movements in underlying rents. Factoring them in as well gives a more sobering assessment of the performance of many retail assets. However, the table below does indicate that the rate of decline in both headline and net effective rents seems to be levelling off after collapsing last summer.

Do rising bond yields point to rising property yields?

We now ponder whether property’s fortunes are about to take a hit. We mention later in the report that development completions are edging up, at a time when tenant demand remains quiet. A more fundamental concern relates to the re-emergence of inflation and the consequent increase in interest rates that would bring. While some commentators believe that inflation is a concern for only the US, yield curves around the world have been moving up in recent weeks. The equity sell-off in mid-May was a direct result of investors factoring in the return of inflation, and higher interest rates, into their portfolios.

In much the same way as the pandemic has accelerated ongoing structural changes to the economy, it has also altered the mindset of commercial property investors. Clearly, the ability to transact has been compromised during much of the last twelve months, but the pandemic has altered investors’ asset preferences. It has also impacted on investors’ ability to correctly price income, risk and obsolescence. Much of the hit to transaction volumes was down to these aspects as to the lack of stock on offer.

Changing asset thinking

The composition of the IPD Quarterly Index highlights the shift in the makeup of the index over time. Ten years ago, for example, almost half of a typical portfolio comprised retail assets, 30% were in offices and the remainder in industrials and a disparate group of ‘other’ assets such as hotels, leisure, buy-to-let residential and care homes. Fast forward five years and the transforming of the typical portfolio was underway. The most noticeable changes were a sharp reduction in retail assets, being replaced by increased allocations to industrial and ‘other’ assets. It is important to note that the move away from retail was occurring before the recent challenges to the high street manifested, and before the severe mark down of retail valuations began. Equally, the increased allocations to industrial properties preceded the major outperformance enjoyed by these assets.

Arriving at today’s typical portfolio, we see that allocations to retail properties are now barely half of what they were ten years ago, while, remarkably, the industrial asset class, historically the Cinderella of the three main sectors, is now the biggest sector in terms of valuation. That transformation was highlighted in our report three months ago when it was pointed out that the stock market listed Segro (an industrial specialist) now has a bigger market capitalisation than British Land and Land Securities (historically the largest by far) combined.

There are two different factors working on these allocation percentages. First, sales and purchases of assets out of and into the Quarterly Index and second, the relative performance of the various sectors. Clearly, the significant underperformance in valuation terms of retail assets and outperformance by industrial assets will have been a major factor in the changes to these allocation percentages. The author calculates that roughly 78% of the reduction in retail assets’ allocation can be attributed to the fall in average values, implying that 22% of the reduction has occurred because of net sales of retail asset to investors whose funds are not measured by IPD. The industrial sector allocations prove even more interesting as relative asset valuation movements explain only 61% of the sector’s increased allocation, indicating that either assets have been purchased from previous owners not measured by IPD or that investors have been developing new estates or adding to existing estates, thereby increasing their valuations.

What is certain is that investors will continue to mould their portfolios towards assets they believe will deliver the best returns. Nimble investors will seek to anticipate changes in fashion like the move into retail warehouses in the early 1980s and the more recent move into distribution and ‘last-mile’ distribution hubs. The above instances of changing sector allocations will not be the last.

Investment in commercial property across the UK amounted to £10.5bn in Q1 2021. Although this was down substantially on the levels recorded both in the previous quarter and in Q1 2020, there are signs that investor interest is on the rise. Certainly, the number of potential investors is increasing and there are clear signs that investment in some of the recently moribund retail segments is growing.

It will come as no surprise that the industrial sector amassed most transactions in the quarter – £3.2bn – the sector’s third highest quarterly total in 20 years.

Summing up

The UK commercial property market has weathered the storm remarkably well. Few commentators a year ago would have envisaged that commercial property would deliver such a resilient performance in such challenging times.

We have long believed that commercial property would continue to deliver sound performance as long as the yield argument held up. There are signs now, though, that as inflationary pressures start to build up globally, so does the prospect of rising interest rates which may feed through to rising property yields. However, we do feel that any such increase in bond yields will be modest as central bankers have indicated that policy rates will be held at current levels for some time.

Where rising interest rates may impact the commercial property market is in altering investors’ appetite for risk. Record highs in stock markets, coupled with sharp mark downs, particularly in the US, are pointing to a reawakening by investors for more risky assets. Any change in emphasis is likely to alter investors’ assessment of the risk premium for their property assets – any upwards reassessment of the risk premium deemed appropriate could well dwarf any increase in property yields brought about by rising bond yields alone. Therein lies the risk for future performance.

News flow will continue to influence one’s take on the future of the high street and the office, with the likelihood of a slimming down of the office stock needed in the future and further consolidation of town centre retail. Vacancy rates are increasing in the CBD office markets, although future development pipelines remain modest by historic standards.

 Central London offices

Take up of central London offices remains weak by historic standards although quarterly figures are gradually increasing from the lows of the second quarter of last year. Lettings in the City and West End combined in the first three months of the year amounted to 1.34m sq ft, down 34% from Q1 2020 but above that of Q4 when take up totalled 747,000 sq ft. At least lettings in Q1 are moving in the right direction, with March take up above those of January and February.

Of increasing concern to office watchers, however, is the build-up of empty office space. With limited levels of take up, completions of new developments and space being released by tenants on to the market, vacancy rates in central London are hitting levels not seen for more than a decade. There is approximately 12.3m sq ft of vacant space in the City, equating to a vacancy rate of 8.9%. Over 60% of that is in the City core where the vacancy rate is over 11%. The West End is faring marginally better – its 7.8m sq ft of empty space equating to a vacancy rate of 6.9%. One saving grace is that the majority of this empty space is of Grade A quality.

Over the course of the next 3½ years (to the end of 2024), approximately 16.6m sq ft of new development and refurbishment is due to be completed in the City.  In the West End, the equivalent figure is 12.6m sq ft. Of that total, 21% has been pre-let, implying that over 23m sq ft is being developed speculatively. While that may seem high in current markets, a return to more ‘normal’ letting markets would soon soak up this new space: average yearly take up in the City and West End office markets has exceeded 10m sq ft over the last decade. However, the scale of developments alone does not tell the full story about the extent of vacant space and its likely path in the coming months and years. Much will rest on how much space tenants feel compelled to place on the market as they themselves opt to downsize their office requirements.

Investor interest in central London offices remains firm but restrictions on viewings and the limited stock being put on the market are curtailing the actual number of transactions. Total deals in the two sub markets in Q1 amounted to £1.33bn, just over half of that transacted in the equivalent quarter twelve months previously. At least the latest quarterly deals exceeded the low points of the second and third quarters of last year. However, by way of comparison, in investment terms, Q1 2021 marked the lowest first quarter in term of transactions since 2009.

The lack of stock being offered to the market was highlighted by the fact that only one of the twelve properties sold in the City during Q1 was first marketed in that quarter.

The future of the office has already been aired in the previous section but a transaction in the West End indicates that one investor has opted to convert unused office space into 42 residential units plus ground floor retail. Bain Capital, the US investor, bought Grosvenor Gardens House in Belgravia for £80m, reputably £10m above the guide price in a competitive bid.

Capital values are still under downward pressure, but by less than fundamentals would have suggested. Despite a weak lettings market and modest levels of investor demand, average City office values fell by just 0.2% in Q1 for a twelve month fall of 2.2%. City offices though outperformed their neighbours as West End offices declined on average by 0.3% in the quarter for an annual fall of 6.6%. Last year marked the fourth successive year that average City office values outperformed their West End neighbours, a trend that has extended into 2021. Given the West End’s lower vacancy rate, lower number of developments coming on stream and the traditionally wider occupier base, that is an anomaly that could be soon reversed.

Summing up.

London office watchers will have been pleased, and no doubt a little relieved that the performance of both City and West End offices has held up so well, so far. Not only did these segments have to contend with Brexit uncertainties, they were faced with further economic uncertainty in the form of the pandemic.

Perhaps the first twelve months will prove to be the easiest period. Perhaps rising vacancy levels, the prospect of a large downward assessments of some occupiers’ requirements and the possible rising property yields will be the story of 2021 and beyond? Perhaps ….

Nonetheless, we still believe that it is premature to signal the end of the office as we know it. The debate over the future use and size of the office will continue for some time. For every major employer signalling the demise of the office, there will no doubt be similar numbers voicing their benefits. What is clear, though, is that the future office will have to offer flexibility and to that end, landlords will have to engage with their tenants (and potential future tenants) in ways not envisaged before.

Sentiment will continue to feature heavily on central London offices. Home to many of Britain’s biggest and high-profile employers, they will continue to generate and dominate press headlines.

Values have been declining for several quarters and only an optimist would suggest a rapid change in direction. With rising vacancy rates, rents will remain under downward pressure for some time, but we repeat that we do see a major hit to valuations in the coming months. Longer term, there is concern that rising bond yields could spill over to push up property yields but more of a worry, in our belief, are changes to the risk premium that investors will require for investing in bricks and mortar.


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

Stewart Cowe, May 2021