2020 Cordatus ESG Awards – The Results!

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To much eager anticipation among team members, the results of the inaugural Cordatus ESG Awards were recently announced. The Award is presented on an annual basis to encourage asset managers to think about ESG in all their activities.

This year, two particular submissions received stood out and it was agreed that this year’s prize would be jointly awarded to two applicants.

So congratulations to Andrew and Douglas for their commitment to improving the ESG credentials of their assets and of Cordatus Real Estate.  Unable this year, for obvious reasons, to present the prize(s) in person, Mike Channing commented:

“I was delighted with the response that this year’s competition produced. The quality of all submissions was high, but the joint winners showed real enthusiasm and initiative in their well thought out and documented projects.

There is growing evidence that ESG factors, when integrated into investment management and portfolio construction, can offer investors potential long-term performance advantages and our aim is to ensure that our team is thinking about these issues as part of their day to day portfolio management”.

Amazon e-vouchers of £75 were awarded to both winners.

Economic and Market Commentary – Q1 2020

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Brexit news

Given the huge amount of column inches that Brexit has commanded over the last four years, and particularly last year, it had to be something quite cataclysmic to take it off the front pages of the media in 2020.  And not only the front pages, but virtually every page.

The coronavirus pandemic has relegated Brexit news to a mere filler in media coverage at a time when the daily ministerial briefings, the number of new infections and deaths, the transmission rate (R0) and news about how and when the lockdown might end are far more important topics and far more pressing issues for a worried population.

However, meetings between the British and EU counterparts are still taking place.  Only now, they are happening online. But that change does not seem to have helped thaw the frosty relations between the two.  Virtual meetings have not altered the impasse that shows no signs of being broken.

Progress this year has been “disappointing” according to the EU’s chief negotiator, Michel Barnier, who also reiterated that “genuine progress” and a decision on whether to extend the transition period were both needed by June. Two further rounds of talks are scheduled before the end of the transition period. Prime Minister Johnson has again reiterated that Britain will not seek an extension to the end of the transition period in December.

May also saw the start of trade negotiations with the United States. One early stumbling block is the US farmers’ desire to increase their share of the UK market. Given the British consumers’ reluctance to accept chlorinated chicken and hormone treated beef, these talks could be just as fractious as the European ones. And with President Trump wishing to go to the electorate at the end of the year with some good news, it is unlikely that the US will easily back down.

Global economy

It is incredible just how much the world has changed over the past three months.  Our previous report did highlight the problems that the coronavirus was then causing, particularly to global supply chains and specifically to the Chinese economy, but we did not anticipate how rapidly the virus would spread and how our daily lives would be impacted.

Our previous report forecast that global output this year would grow by 3.3% – dull by historic standards, but certainly positive. Now red pens have been taken to all such forecasts: instead of growing, world output is now forecast to contract by 3%, significantly worse than at the time of the global financial crash (in the worst year of the crisis, 2009, world output dipped by less than 1%). Such a forecast puts the current global situation on a par with the Great Depression of the 1930s.

It is truly a global pandemic, the like of which has not been seen for over a century when ‘Spanish’ flu was reported to have caused the death of up to 100 million. The United Nations have reported that 81% of the world’s workforce of 3.3 billion has had their place of work fully or partly closed because of the outbreak and on an even more sombre note, the charity Oxfam warned that the economic ramifications from the spread of the virus could force more than 500 million people into poverty.

Countries in the firing line have imposed containment measures which prompted shutdowns of large parts of the economy. Coupled with these measures have been huge fiscal stimuli – which for many countries were substantially greater than those during the GFC – such as providing additional funds for health services and paying part or all of affected workers’ wages. While these measures will help in the short term, this crisis is one without precedent and one of the biggest unknowns is how long any measures designed to limit the spread of the virus will be needed. We also do not know how this situation will pan out over the course of the year.

As we write, we welcome news that some countries are beginning to ease their lockdown strategies – but any easing too soon risk the return of another wave of infections. With every country at different stages of the epidemic and with no clear ending of the crisis, it is virtually impossible to quantify the extent to which economies will be hit, and for how long any particular economy will be affected.

However, and bearing in mind the above caveats, our 2020 forecasts have been slashed across the board. Expectations for the IMF designated ‘advanced economies’ have been cut from +1.6% to -6.1% (a cut of 7.7 percentage points). Few economies will escape moving into negative territory; China, the original epicentre of the virus, is likely to grow this year by only 1.2%, significantly lower than recent trend growth of around 6%. Some of this year’s weakness is expected to be made up next year, but all forecasts – for 2020 and 2021 are subject to a higher than normal degree of risk.

Worrying though these forecasts are, it is chilling to read that the new head of the IMF, Kristalina Georgieva, has admitted that her organisation’s forecasts may well be “too optimistic”.

For what it is worth, official figures show that the US economy contracted by an annualised 4.8% in the first quarter while China, where containment measures were introduced much earlier in the year, saw its output decline by 6.8% – the first quarterly contraction there since records began in 1992.  Data from the major European countries were equally as bleak.

Global Economic Forecasts

% growth pa 2019 (est) 2020 (f) 2021 (f) 2022 (f)
US 2.3 -5.9 4.7 n/a
Eurozone 1.2 -7.5 4.7 n/a
Japan 0.7 -5.2 3.0 n/a
All advanced countries 1.7 -6.1 4.5 n/a
Emerging & developing countries 3.7 -1.0 6.6 n/a
World 2.9 -3.0 5.8 n/a
Source: IMF, April 2020

Note in view of the uncertainties surrounding economic growth in the near term, the IMF has abandoned its forecasts for 2022

The EU economy

Continental Europe has been amongst the hardest hit areas in terms of coronavirus victims and deaths. Once the epidemic spread outside China, Italy and later Spain became the focal points. Italy has been particularly badly hit and the measures taken by the Italian government, similar to those taken elsewhere, of supporting business and workers, is a burden the heavily indebted country can ill afford.

The latest GDP forecasts show that the euro-area is expected to contract by 7.5% this year with a partial rebound of 4.7% growth next year. Cumulatively, the two years imply a contraction of 2.8%, compared to a previously expected aggregate growth of 2.7% over that period. As would be expected, the economies of Italy and Spain, the most affected by the virus, see the greatest forecast contractions this year: Italy by 9.1% and Spain by 8.0%. Even with a modest rebound in 2021, both these economies are forecast to contract in total by roughly 4 percentage points over 2020 and 2021.

Even northern European countries, which so far have escaped the worst of the virus, are not immune to the sharp contractions expected this year. France and Germany are expected to contract by 7.2% and 7.0% respectively although they are both tipped to bounce back stronger and quicker than their southern neighbours.

First estimates of Q1 activity already show the scale of the downturn.  As expected, the economies of Italy and Spain contracted sharply by 4.7% and 5.1% respectively. It was France which suffered the most of all the major economies, declining by 5.8% – the largest fall since the quarterly data was published in 1949. The overall figure for the eurozone was a contraction of 3.8%. These Q1 numbers – bad as they are – are just the aperitif: Q2 declines for all countries will be significantly more negative.

Eurozone Economic Forecasts

% growth pa 2019 (est) 2020 (f) 2021 (f) 2022 (f)
Eurozone 1.2 -7.5 4.7 n/a
   France 1.3 -7.2 4.5 n/a
   Germany 0.6 -7.0 5.2 n/a
   Italy 0.3 -9.1 4.8 n/a
   Spain 2.0 -8.0 4.3 n/a
Source: IMF, April 2020        

The UK economy

The magnitude of the anticipated drop in UK output caused by the coronavirus this year is matched only by that of the huge sums of money pledged by the government to ease the financial pain of business and employees together with the open-ended budget allocated to the NHS to fight the virus.

The first quarter of the year was relatively unaffected as the bulk of the strict lockdown measures were only implemented on 23 March but the collapse of the economy this (April to June) quarter will be on an unprecedented scale, and certainly greater than anything encountered in the last 100 years. Forecasts for Q2, as collated by the BBC, range from a best of -7.5% from JP Morgan to a jaw-dropping -24% from Capital Economics.  And while it may be hoped that there will be some form of recovery in the second half of the year, the initially expected ‘V-shaped’ pattern of the economy – a sharp decline followed by an equally strong recovery – now seems unlikely with more economists favouring a double-dip or ‘W-shaped’ recession involving a second but less deadly spike of infections.

Our in-house forecasts anticipate annual GDP falling by 6.5% this year. That outcome is in the middle of the BBC’s sample (which ranges from a most optimistic -3.6% (JP Morgan) to a worst view decline of 12% (Capital Economics) but such numbers are meaningless when policymakers have so little control over the spread of the virus. Epidemiologists, just as much as economists, are necessary to determine the near-term pattern of the economy.

 There is no consensus of the magnitude of the UK GDP downturn

Some recovery is anticipated next year but it will not fully make up this year’s shortfall and we expect growth of 4.0% in 2021. Taking this year and next together, our current belief is that the UK will contract by a cumulative 2.5 percentage points; three months ago, we expected cumulative growth of 2.9%. Our revised forecasts therefore indicate a cumulative hit to the economy of almost 5½ percentage points – massive in historic terms and not dissimilar to the period of the global financial crash.  Looking at 2020 on its own, the magnitude of the contraction will not have been matched since the combination of the Great War and Spanish flu ravaged the economy over the 1918-20 period.

The drain on the country’s finances will be huge; lower corporate taxes, lower employee income tax (despite the furlough scheme) as well as funds pledged to workers, companies and to the NHS. The Bank of England did cut interest rates to an historic low of 0.1% on the day of the March budget but even so the financing of all these recently announced measures is an unwelcome additional hit to an already stretched UK government debt burden. We will all be paying for this debt for some time, even if a vaccine for coronavirus is found quickly. If a vaccine is not developed soon, the costs for the UK and other countries will become even more astronomical.

 Historic and forecast UK quarterly GDP growth

UK Economic Forecasts

% growth pa 2019 (est) 2020 (f) 2021 (f) 2022 (f)
GDP growth 1.4 -6.5 4.0 n/a
CPI inflation 1.9 1.2 1.5 n/a
Consumer spending 1.2 1.1 1.4 n/a
Base rate (end year) 0.75 0.1 0.5 n/a
Source: IMF, April 2020

As we write, the government is deliberating on the precise means to loosen the lockdown measures, allowing a return to some normality and permitting many more workers to return to gainful employment. Health issues to one side, a return to work is seen as imperative as it is revealed that the government is now paying the wages of nearly a quarter of UK jobs.  As many as 6.3 million workers (23% of the UK workforce) are receiving government money through the job retention scheme.

However, it seems that not everyone believes that the economy will quickly return to normality. A recent poll by YouGov indicates that up to two-thirds of the population would be reluctant to enter gyms, pubs or coffee shops when they reopen.

Not all parts of the economy will recover as quickly

Market Commentary

News that average commercial property valuations fell by just 2.4% over first quarter of the year may have brought some relief to investors, given the extreme volatility in equity, bond, currency and commodity prices recently. But such tranquil movements in property valuations may be short lived, particularly so if the period of lockdown in the UK is longer than initially expected.

The UK announced lockdown measures on 23 March, around the time when the valuers were beginning to issue their end Q1 valuations.  While average valuations for the market as a whole, as measured by the IPD Quarterly Index, showed a further 2.4% fall over the first three months of the year, the more frequent, but less representative, IPD Monthly Index showed that March itself accounted for that magnitude of fall.

The fall in capital values seems to be accelerating

In line with many other indicators, investment interest in UK commercial property appears robust when looking at deals over the first three months of the year. At £13.7bn (source: UK Economic and Real Estate Briefing, BNP Paribas, April 2020), investment turnover was 21% higher than the equivalent figure in 2019 and in line with the 10-year average. But deals were noticeably slower in the latter part of March. It was clear that UK institutions were particularly wary of the market in Q1, being heavy net sellers over the quarter.

 Overseas investors still remain keen on UK property

The art of commercial property valuation is a highly complex and sometimes mysterious process at the best of times, involving as a crucial crutch, the availability of similar properties with which to compare. In these more challenging times, when such comparables are few and far between and when even the previously simple task of inspecting a property is often impossible, these valuations take on a much greater degree of subjectivity. In only the fifth time in the last 150 years, the Royal Institution of Chartered Surveyors have instructed valuers to impose a ‘market valuation uncertainty’ clause, thereby stating that a higher degree of caution should be attached to the valuation of individual properties. By extension, this uncertainty to value can be extended to that of funds; the reason why many unitised property vehicles have suspended trading.

Parallels with the GFC cannot be ruled out; the fall in UK output is expected to be of a not dis-similar magnitude, but we do not foresee falls in property valuation similar to that seen a decade ago. While, arguably, commercial property valuations are stretched, and have been so for some time, the extent of over-valuation is not as bad as it was in the mid-late 2000s while crucially, the industry is not saddled with as much debt, thereby ruling out the necessity of a significant number of forced asset sales. But that is not to say that there will be no distressed sellers. Cash flow problems will surface for many investors.

Share prices of REITs were falling significantly before the lockdown; such moves tend to pre-empt a similar fall in property valuations. We pointed out in our last report that rents were declining across the retail sector while rents were virtually static in the office and industrial sectors. With little tenant demand likely in this uncertain period, it is difficult to see any improvement over the rest of the year at least: consequently, we expect rental declines across most of the market to continue in the coming months.

Average capital values in all three sectors are now declining

The retail sector will continue to see the sharpest valuation markdowns. Already we have seen a slew of retailers wishing to engage in “rent discussions” – a euphemism for at best rent deferrals or in some cases a rent reduction – some have announced further plans to downsize their portfolios of outlets, while some (most publicly and most strikingly, Primark) have revealed they have sold nothing since the lockdown. Some have requested changes to the frequency of rent payments – from quarterly to monthly – and in some cases, further concessions from monthly in advance to monthly in arrear. In an ideal world, the total rent paid under these new arrangements over the term of the lease would be unaffected, even if the timing differs, but the world at present is certainly not ideal, and some businesses will collapse before the lease ends.  It is inconceivable to believe that this sector will not continue its downward repricing over the coming months.

While it is tempting to consider that commercial property is currently competitively priced against other asset classes, given its yield premia, such an argument ignores the risk factor of tenant failure (or the reduction in rent demanded by a struggling business). This risk has never been higher and until business returns to some form of normality, this risk will remain and perhaps increase. Rarely has a portfolio’s covenant strength been so important and rarely will that of a tenant be subject to such rapid change. Businesses with reduced or minimal sales coupled with the ever-present, if perhaps temporarily reduced, overheads are not all going to come through the coming months unscathed and some, at least, will fall by the wayside. Many previously profitable entities will suffer heavy losses and at best may be forced to downsize their operations, or at worst face collapse.

The key question facing investors is how long the current exceptional period will last. If things get back to normal (or near normal) soon, and by that, say over the next three to four months, then hopefully not too many businesses will fail. If it takes much longer, we can expect a significant number of company failures, empty premises and with little demand for that space. That gloomy scenario is a reminder of the deep recession in the early 1990s.  It was initially anticipated that it would be a ‘short-sharp’ recession, one in which most companies could weather the storm; in reality, it proved to be one of the deepest and longest lasting recessions in history, wiping out numerous companies and driving vacancy rates up across the board. That period was exacerbated by a continuing development boom, which thankfully we are spared at present, but those with long memories will not want a repeat of that period.

The portfolio of the future

Much is being written about the possible winners and losers in the commercial property field: will internet/click and collect finally kill off the high street as we know it?; will there be even more demand for distribution warehouses?; what will be the optimum size of office and how should the configuration of the workspace look post crisis? Everyone will have a view about these and a myriad of similar ‘strategic’ questions.

Terry Smith, chief executive of Fundsmith LLP and star equity stock picker cautions on over-analysing the situation. In an article published in the Financial Times at the end of April, Smith believes that needless analysis is conducted on speculating on what will happen – when will the lockdown end?; what will happen to the travel and hospitality industry?; who will be the winners – makers of disinfectant and masks; drug companies? – and so on. This over-analysis sentiment, I believe, can be carried over to the commercial property market. The key question facing property fund managers just now is how secure are the tenants in one’s portfolio? At this stage, no one really knows. Covenant strength analyses are backward looking anyway. This crisis is dynamic in nature and seemingly strong businesses can collapse tomorrow. Even if one could identify potential tenant defaulters, how easy is it to remove that tenant from one’s portfolio? By selling the asset? By engineering a tenant replacement?  In this market, investors are as wary about investing in dodgy tenants as you are.

I believe that fund managers must resist buying into the latest fashion, e.g. buying properties with pharmaceutical tenants or selling those with travel agents on the lease. Rather, seek to maximise one’s income from the existing portfolio – and that may include accepting reductions in rent from certain tenants, particularly if these reductions mean the difference between collapse of the business and survival.

It is easy to predict that the retail sector will remain out of favour with investors.  The current crisis is merely accelerating a process that started over a decade ago and which has manifested in significant valuation declines already. It is also tempting to think that the industrial sector will also continue to benefit from the growth of distribution centres. But here, be wary of the yield; traditionally, industrial assets commanded significant yield discounts to the other sectors – now they stand at premia to the others. It is perhaps the office sector where the biggest debate ensues. What will be the optimum size, configuration and location of tomorrow’s occupiers? Will these discussions go the way of ‘hot desking’ which was thought to be the way forward 10 or 20 years ago but never really crystallised? Or will social distancing rules in the workplace dictate larger floorplates per employee? These are the debates landlords should be planning to have with their tenants, if not now, then when the crisis subsides. These discussions crucially should involve developers, not just at the stage of letting, but during the planning and construction stages too.

Central London offices

Not surprisingly, the short-to-medium term outlook for central London offices has changed dramatically since our last report three months ago.  We had noted the effect of the ‘Boris bounce’ in both business and consumer confidence which suggested that this momentum could well feed through to both occupier and transactional markets this year.

Indeed, there were signs of this happening in January, February and early March, although there were mixed fortunes for the City and West End markets in terms of take-up to that point. Hopes of a strong March were dashed when the full extent of the UK’s lockdown response emerged. In both markets, take up in March collapsed compared to the same month last year: take-up in the City, at just under 500,000 sq ft, was down 22% on March last year while the West End saw an even more dramatic 63% fall. Prior to March, the fortunes of both markets differed: City lettings an impressive 71% increase for the first two months of the year compared to the January and February 2019, the West End down by over one quarter. Part of the West End’s modest take-up figures is simply because there is very limited available stock for interested occupiers with current vacancy rates hovering around the 4-4¼% mark.

Central London office take up – mixed fortunes for the City and West End

There was a clearer picture when it comes to investment turnover. Transactions were already suffering the investment jitters – for example, equity markets were exceptionally volatile for much of that period. The volume of deals was already down even before the lockdown was announced. Transactions in the City and West End office markets over Q1 fell to £1.35bn and £1.05bn, down 38% and 10% respectively on the equivalent figures last year. Caution should be taken with the City figure as last year’s Q1 total included the £1bn Citibank purchase of 25 Canada Square last March.

City investment turnover collapses in March

Most of the March deals had been initiated well before the severity of the lockdown measures became apparent. Consequently, there were few deals started in the closing two weeks of the month. With many investors content just to wait and see how the landscape lies, with the timeframe and severity of the trauma to the economy still unknown, and with widely differing views as to the value of property assets in this environment, it is clear that transactions in Q2 and perhaps over the rest of the year will be severely reduced.

While new lettings may be more challenging to find in the short term, the one benefit brought by the lockdown has been the inevitable delays to the development pipeline, which will produce further constraints on future supply. This will particularly affect occupiers wishing large premises, where current options are extremely limited.

Central London office values fell in Q1, reversing a ten-year upward movement. Bar a sharp pause at the time of the EU-referendum in 2016, values have been on an upward trend since the end of the GFC-induced correction in 2009. Since then, average capital values had risen by 110% in the City and 88% in the West End before the Q1 fall of 0.2% and 0.8% respectively. It seems unlikely that values will pick up again over the course of 2020, but the underlying, if temporarily dormant, demand for space and the limited development ongoing at present should limit any further falls in valuation.

Central London office rents are falling

While the short-term prognosis for central London offices has deteriorated since our last report, particularly on account of the virus (and Brexit uncertainties are not helping), fundamentals remain relatively positive. Underlying tenant demand is strong even if letting deals are quiet just now while the delays to development completions reduces the amount of space available. Nevertheless, office values in London, like most other commercial property markets are going to have to weather some dull quarters before both the investment and occupier markets recover.

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

Stewart Cowe, May 2020

Cordatus Real Estate secures detailed planning permission at Littlehampton

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Cordatus Real Estate on behalf of Cordatus Property Trust (CPT) has secured detailed planning permission from Arun District Council for the development of four new commercial units (Use Class B1, B2 or B8), at their holding at Minster Court, Littlehampton.

The estate currently comprises ten single storey industrial units built in the early 1990s in two terraces, containing five units each, totalling 2,369 sq. m (25,500 sqft). The approval will allow for an extension to the original terraces by a further 1,200 sq. m (c. 13,000 sqft) with two new units to be added to each side.

Andrew Murray, Asset Manager for Cordatus Real Estate, said: “We are delighted to confirm that our proposals have been approved, making it a very positive start to the year. The development is ideally placed to benefit from a lack of suitable industrial stock in the area and we have already received strong interest in the units.”

Stiles Harold Williams (SHW) acted for Cordatus in securing the planning approval.

Economic and Market Commentary – Q3 2019

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Brexit news

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

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

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

Global economy

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

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

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

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

The EU economy

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

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

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

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

The UK economy

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

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

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

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

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

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

Market Commentary

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

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

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

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

Central London offices

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

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

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

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

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

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

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


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

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

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

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

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

Cordatus Real Estate wins 2019 MSCI Real Estate Data Quality Award.

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MSCI, the leading provider of Real Estate data have awarded Cordatus the 2019 MSCI Real Estate Data Quality Award.

This accolade has been awarded for achieving an exceptional level of data quality achieving an average score above 95% across our funds during 2018.  The scores are based on four categories – timeliness, completeness, accuracy and engagement during the period.

Sharon Gibson, Finance Director commented “Cordatus prides itself on operating to the highest ethical standards in managing its clients’ interests. We are delighted to have received an award that recognises this.”

Cordatus Directors on peak form

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Cordatus Directors Tom Laidlaw and Mike Channing recently completed a successful ascent of active volcano, Mt Teide (3,718m; 12,198ft) in Tenerife in the Canary Islands.

Following an overnight stay at the high altitude Refugio Altavista, a pre-dawn climb to the summit witnessed sunrise over the mountain and the world’s largest shadow over water.

Mike commented “both the ascent and descent were tough, but the clear air has energised us to tackle the market challenges of the next few weeks and the fast approaching Brexit date”.

Economic and Market Commentary – Q2 July 2019

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Brexit news

Brexit claimed its second prime ministerial victim when Theresa May was forced to resign ushering in the distinct possibility of a ‘no deal’ exit with the July appointment of Boris Johnson as PM, the third since the EU referendum three years ago.

It is clear that the deal negotiated by Mrs May and the EU, which was defeated heavily by parliament three times, is now dead but there is, as yet, no clarity on the form of exit that the new PM’s team will pursue. The prospect of the UK and the EU failing to agree an exit solution, leading to a disorderly exit has increased in probability terms, despite members of parliament voting down that prospect.  That likelihood of that scenario has heightened by the EU’s apparent unwillingness to reopen negotiations on a revised deal.

First quarter GDP was boosted by inventory stocking prior to the original end March exit, but this increase in activity was offset in April when the economy contracted. Stockpiling aside, the continued uncertainty about the timing and form of Brexit is causing major problems with business.

The appointment of Johnson has prompted another sharp fall in the value of sterling. This is likely to lead to higher inflation and will pose some problems for the Bank of England. The global slowdown, coupled with the wait and see attitude of many UK companies would, in normal times, see the Bank follow traditional monetary paths in cutting interest rates to attempt to boost the economy. Instead, the prospect of higher inflation would tend to suggest the complete opposite of that tactic.

Global Economy

Extending the weakness inherent now for over a year, the global economy remains subdued. Stock building in the US and UK aside, data in the first half of the year pointed to a dull start to the year although as 2019 progresses, this weakness should subside.

Much of the recent concerns relate to the threats to global trade most noticeably the spat between the US and China which shows no signs of abating. Coupled with a slowdown in manufacturing across the globe – not helped by new emission standards for cars – weak business and consumer durables spending, it is clear that both corporates and consumers are holding off big ticket spending during these uncertain times.

Risks to the global forecasts have been skewed to the downside for some time and it is clear that these risks have intensified over the last three months. If global stock markets are indicators of what lies ahead, then the recent extreme volatility paints a very worrying picture particularly concerning the trade dispute between the US and China. Business confidence across the globe has been hit for some time by the escalating trade war and it has not been helped by the ongoing uncertainty about the UK’s economic future.

The major risk factor is that these concerns sap confidence further, leading to weaker investment, hinder global supply chains and adversely hit global growth to below the base case scenario.

The forecasts for the global economy for this year has been edged up by 10 basis points to 3.2%. A US upgrade since the last quarterly report of 30 bps accounts for this increase with few material changes elsewhere although downgrades are apparent in many of the larger ’emerging and developing’ countries, most notably the ‘BRIC’ countries: Brazil, Russia, India, China and South Africa.

The EU Economy

Forecasts for the Eurozone are broadly unchanged from those of three months ago following the heavy downgrades that were initiated then. GDP expectations for the zone as a whole remain at 1.3% this year with a modest downgrade in Germany being offset by an upgrade in Spain.  Next year, an improvement in Germany’s fortunes allows the forecast for the Eurozone to be upgraded by 10 basis points to a still underwhelming 1.6%.

Outwith Germany, the forecast for Spain has been increased for this year, reflecting strong levels of investment and weaker than expected levels of imports so far this year. France forecasts are unchanged this year and next, helped by fiscal measures and the dissipation of the effect of the continuing street protests.

All forecasts for the single currency zone are still based on an orderly Brexit and a resolution of the trade spat between the US and China.

In common with other area of the globe, the economy of the Eurozone slowed in Q2 after a modest 0.4% tick up in the previous quarter. The flash, first estimate for growth in Q2 has come out at 0.2% for both the single currency zone and for the larger EU. This dull outcome does nothing but strengthen the case for additional stimulus measures by the European Central Bank, whether by cutting interest rates further or by reintroducing some form of quantitative easing.

The manufacturing and export focussed Germany suffered a contraction in Q2, according to the flash estimate. A decrease of 0.1% was widely expected and there is some concern, as in the UK, that a further poor quarter leads to Germany technically going into recession.

The UK Economy

Neither Prime Minister Johnson nor Chancellor Sajid Javid would have been particularly buoyed with the news so soon after taking office that the UK economy contracted in the second quarter. A negative reaction to the first quarter’s stockpiling ahead of the initial date of Brexit had been anticipated but the outcome of a 0.2% fall in GDP was worse than the flat growth expected.

It was not just the manufacturing sector that dragged the economy down: the construction sector also weakened, and the normally buoyant service sector stagnated. In addition to the unwinding of the stock building during the post March period, the second quarter was affected by the shutting down of car factories around the original exit date. Additionally, the UK was not immune to the general malaise apparent in the slowdown of global trade which exacerbated UK companies’ reluctance to commit to investment.

It remains extremely challenging to anticipate the progress of the UK economy over the rest of the year, and perhaps for some time after. We are still no closer to understanding the form of Brexit, even if some clarity has emerged over its timing.  Mr Johnson’s claim that the UK will definitely leave the EU on the 31st October, “deal or no deal” has angered and worried some politicians and it is still within the bounds of possibility that there will be a further delay initiated by the EU, and not by the UK, to prevent a damaging and disorderly no-deal exit.

Consequently, attempts to determine the possible course of the economy are mired with difficulty. Our forecasts anticipate some mutually agreed exit strategy is reached, followed by a gradual transition to the new regime.  Were that not to occur, one can factor in a much more pessimistic set of GDP forecasts for this year and next.

The news on the high street does not get any brighter. Despite wage growth now having outpaced inflation for some time, any extra spending has been bypassing the high street where footfall has fallen – in July – to its worst level for seven years. Consequently, vacancies in the high street now exceed 10%, its highest level for 4½ years. One crumb of comfort from recent statistics is that footfall in retail warehouse parks have increased.

Market Commentary

Capital values continued to weaken almost across the board in Q2 with only industrial properties still backing the downward trend. Even there, growth has moderated significantly from the highs of only one or two years ago, down to a modest 0.6% in the quarter.

As has been the case for the last 18 months, retail values continue to see sharp reductions, although the Q2 fall was a touch less severe than in the previous quarter. Shopping centres once again bore the brunt of the valuers’ red pens; the average decline for Q2 still a massive 4.0%, making a huge 18% fall over the last two years.

The travails of the retail sector have been well trailed in previous reports, as have the problems relating to shopping centres. Interim results from stock exchange listed REITs Intu and Hammerson and from the owner of Westfield Stratford have highlighted just how challenging conditions are.  An asset writedown of £872n (representing a six month valuation fall of 9.6%) over January to June led to Intu posting a six month pre-tax loss of £840m.  In tones reminiscent of the property crash of 2007 – 09, Intu revealed that its balance sheet would require strengthening – by selling non-core assets, by converting its empty stores into residential, hotels and flexible offices and if need be, by raising fresh equity – in order to avoid breaching its banking covenants.

Rental income across many retail assets is being compromised as landlords suffer from retail failures and rent cuts following company voluntary arrangements. Intu, for example, notes that its net rental income had fallen 18% over the six months.

Meanwhile, industrial properties continue their upward trajectory. A modest 0.6% growth in Q2, means that average values have risen by 1.2% this year, which, while still positive, is a pale shadow of the 11.4% growth over 2018 and 13.9% over 2017.

As has been the case for several quarters, the performance of offices was midway between that of retail and industrials. However the average value of all offices slipped fractionally in Q2, for the first time in three years.  While the value of both City and West End average values dipped slightly, average values outside London continued to post small increases.

Central London Offices

Investment in central London offices has dropped significantly this year and while it is easy to point the finger at Brexit uncertainties for this factor, in reality office investment has experienced a similar slowdown in other ‘global’ cities. Indeed, investment in some markets has seen a much greater falloff, such as New York, Frankfurt and Hong Kong, where investment deals in the first six months of the year are down by around 50%, Tokyo (down 43%) and in Paris (down 36%).  It is clear from these statistics that Brexit is just one of the many factors affecting sentiment to commercial property and where the trade spat between the US and China is adversely impacting on funds’ investment decisions.

Investment in City of London offices in Q2, at £821m, was the lowest second quarter figure this century while in the West End, deals worth £986m was the lowest equivalent figure for ten years. Investment demand is still there; it is the severe shortage of available product that is holding back more deals with owners preferring to hold on to their assets in the light of few clear investment opportunities appearing to invest any cash realised.

Over the first six months of the year, turnover in the City amounted to £2.99bn, while that of the West End totalled £1.89bn, down 47% from that in the City last year and down 48% on the five year average first half total in the West End.

In terms of letting, City take up in Q2 was fractionally ahead of the low Q1 figure which meant that over the first six months of the year, the 2.5m sq ft take up was 30% down on the similar period last year. It was noticeable that lettings for space below 5,000 sq ft were most numerous with only one deal so far this year for space above 100,000 sq ft.  West End take up, at 836,000 sq ft in Q2, was 30% lower than that of the strong Q1 bringing the total let in the HI to 2.1m sq ft let, similar to the equivalent figure last year but ahead of the long term average.

Vacancy rates in both markets remain steady, at 5.2% in the City and 4.1% in the West End. In both markets, developments in the pipeline are beginning to accelerate. From now until the end of 2022, over 15m sq ft is forecast to be competed in the City while the comparative figure in the West End is 10m sq ft.  However, a sizeable amount of this additional space has already been pre-let: 27% in the City and 36% in the West End.

Capital growth in both central London office markets has been slowing for a couple of years and Q2 witnessed the first simultaneous fall in average capital values – albeit minor at 0.1% – in both the City and West End for over five years. The rolling 12-month City office growth has stalled from 3.7% in mid-2018 to 1.1% now and from 2.5% a year ago to 0.8% now in the West End.


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

Research Author: Stewart Cowe

Triathlon World Championships

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Cordatus director Gavin Munn recently competed in the Triathlon World Championships in Lausanne, Switzerland as part of the GB Age Group Team.

Gavin was competing in the Olympic distance event comprising 1500m swim, 40k cycle and 10k run. Having previously competed in the GB team at the European Championships Gavin was reasonably well prepared for the race but exceptionally hot weather and level of competition made for a particularly tough couple of hours for a fair skinned Scot used to racing in about half the temperature! Despite a poor swim he had a strong bike and solid run finishing in 21st place in his age group. He says he has retired from competition for a while but we shall see…

Cordatus Economic and Market Commentary Q1 – April 2019

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Brexit News

Despite writing this report in mid May, fully six weeks after Britain’s original date for leaving the EU, we are no further forward to knowing what form the exit will take, when it will occur, or indeed, whether it will happen at all. Prime Minister May brought her own version of the exit strategy to the House of Commons three times, suffering heavy, if falling, magnitudes of defeat while members of parliament, in an unusual move, themselves brought eight different versions of ways forward – ranging from retaining the customs union, to a no-deal solution to a further referendum – all without success. As the EU (and many frustrated voters) have said; we know what you don’t want, now tells what you do want.

The latest plan, to seek some compromise solution with the Labour party, so far does not seem either to be coming up with the goods, but this long running soap opera has a possible further five months to run, with the EU having agreed a potential delay to the end of October. It is not clear whether any progress can be made in that timeframe.

Meanwhile, the government has reluctantly accepted that the UK will have to take part in the European elections at a cost of £150m – one of many ‘one-off’ costs that the country is having to bear because of the current impasse.

Global Economy

The global economy suffered a distinct slowdown in the second half of 2018 and this feature continues to negatively impact activity this year. The state managed decline in China’s activity, where growth is forecast to dip to 6.3% this year and to 6.1% next year, is one of the key reasons for this slowdown, but the on-going trade tensions between the US and China are also not helping.

These trade tensions, together with continuing uncertainties over Brexit, are hitting business confidence. That, coupled with a slowing export market, is affecting global trade, particularly hampering export-focussing countries.

At a global level, the slowdown that has been evident for the last nine months or so is likely to trough in the middle of this year, with a gentle uptick thereafter. This improvement is predicated on some policy stimulus in China, the ending of some particular negative factors in Europe and a stabilising of conditions in some of the distressed emerging market countries such as Argentina and Turkey. Within the advanced economies, however, there is little positive momentum to note as activity is likely to gradually slow as the impact of the US fiscal stimulus fades.

Our global growth forecasts have been trimmed by 20 basis points to 3.3% for 2019 but are maintained at 3.6% for next year. The forecasts for the advanced economies, in aggregate, have also been cut by 20 bps to 1.8% this year and are maintained at an anaemic 1.7% for 2020.

We have not altered our view that the balance of risks is tilted to the downside. The key global trade issue remains the on-going trade talks between China and the US. The latter’s decision to impose higher tariffs on specific imports from China – up from 10% to 25% – is likely to prompt retaliation. Resolution of the trade tensions would give a fillip to global growth, but further escalation of these tensions and the accompanying increase in policy uncertainty would have the opposite effect. On balance, we are concerned that there still remains the distinct possibility that there will be a sharp deterioration in market conditions.

The EU Economy

The Eurozone has borne the brunt of the heaviest downgrades over the last three months. The single currency bloc has not been immune from the global slowdown but it has also been subject to some significant country issues which have combined to lower the zone’s anticipated output. Forecast growth in the Eurozone, in aggregate, has been trimmed from an already weak 1.6% for this year and 1.7% for 2020 to 1.3% and 1.5% respectively.

Germany and Italy have been particularly badly affected – the former on account of its export-oriented stance and the slowdown in the automotive industry: the latter on account of rising bond yields and the resultant impact on the cost of the country’s huge sovereign debt mountain. Our forecasts for both countries have been cut by 50 bps this year to a less than impressive 0.8% and 0.1% respectively. Even this year’s forecast may be too optimistic as the German government expects growth of only 0.5%. The March PMI reading for Germany showed a worrying fall to levels not seen since the midst of the euro area sovereign debt crisis. Forecasts for France, too, have been reduced from 1.5% to 1.3% for this year. France and Germany have also suffered a 20 bp downgrade to 1.4% for 2020.

Growth for the Eurozone as a whole in Q1 came in a little stronger than anticipated, at 0.4%, double that of the previous quarter. There were encouraging signs for the ‘big-4’ Eurozone economies where growth was higher than expected. However, this relatively positive showing is not expected to continue over the rest of the year. Italy’s economy returned to growth after two quarters of contraction, but questions still remain over the country’s medium term outlook.

Perhaps the most encouraging sign for the Eurozone is the fall in unemployment. The rate of 7.7% is the lowest since 2008, before the onset of the global financial crash and down from 8.5% in the last 12 months.    

The UK Economy

Given the negative effect that the tortuous negotiations followed by the House of Commons impasse in agreeing to any form of Brexit is having, it is understandable that British business finds the prospect of a further period of parliamentary negotiation particularly frustrating.

It remains commendable that the UK economy has remained so resilient over the last year or so, with so many questions still unanswered, especially regarding how trade will fare after Brexit. The latest IMF forecasts for the UK show a reduction from those published three month ago, but at a time when virtually all countries have suffered downgrades. For the UK activity to be broadly expanding over the next two years at the same rate as the Eurozone says as much about the UK’s resilience as the EU’s inherent economic ailments.

The UK economy rebounded in the first three months of the year, posting quarterly growth of 0.5%, significantly better than the lacklustre 0.2% seen the previous quarter. Despite this better than recent levels of growth, much of the activity was accounted for by stockpiling ahead of the UK’s original exit from the EU. The Office for National Statistics reported that “manufacturers were clearing their order books before the planned departure date”. That helped the manufacturing side of the economy to grow in Q1 at its fastest pace since 1988. While it is unlikely that this level of activity will be sustained over the rest of the year, as stocks are likely to be run down, evidence supports the belief that household consumption growth is remaining “solid” and crucially, business investment did not fall “for the first time in four quarters.”

Our forecasts for the UK for this year and next have been trimmed by 30 bps and 20 bps respectively, to 1.2% and 1.4% from those of the previous quarter, reflecting the weaker global trade position as well as Brexit-induced uncertainties. An outcome of 1.2% this year would be the lowest annual growth in a decade. These forecasts, however, are predicated on an orderly exit from the EU. Exiting without a deal, or by some other chaotic way would likely damage the economy over the short term, with consequent downgrades to the above figures.

The downside to these strong manufacturing numbers is the sharp rise in the trade deficit brought about by higher imports ahead of any possible trade sanctions on a no-deal exit. The trade deficit doubled to £18bn in the quarter, a figure which increases to an eye-watering £43bn – a record – at the trade in goods (not services) level.

Market Commentary

According to the latest, Q1 2019, MSCI Quarterly Index, capital values for the market as a whole posted a three-month fall of 0.75%. The trend in capital values has now been declining for five successive quarters, and Q1 was the second quarterly fall in a row. Capital values in the hard pressed retail sector once again contributed most to the down rating, although value declines there (2.6%) were not as bad as the previous quarter’s 2.8%. There was minimal change in all office values in the quarter, the main feature being a 0.2% fall in average city offices, the first decline there for three years. The recent outperformance by the industrial sector continued but here, too, capital growth in the quarter fell to a three year low.

Overall quarterly total returns for the market fell to 0.38% with the albeit slowing industrial sector delivering 1.7% (barely half that of Q4 2018), offices 1.1% and retail -1.3%.

Our reports in recent quarters have highlighted the problems retailers are encountering in the high street and in the retail market generally. The above MSCI figures are witness to the fundamental re-pricing of retail assets that has been underway for some time and is likely to continue for several more quarters yet. Two separate but linked reports show just what pressure landlords are having – one from PWC showing that the number of new shop openings fell to the lowest on record last year and the annual results from one of the UK’s largest shopping centre owners, INTU, which revealed that like for like rents were 6% lower than a year ago and vacancy rates had increased by 1.1 percentage points in the quarter to 4.4%.

The PwC report, which was compiled by the Local Data Company, highlighted that in 2018, an average of 16 shops a day closed across the top 500 high streets in the UK. Compounding that loss was the fact that an average of only nine shops a day opened, leading to the largest ever net annual decline of 2,400 shops last year. Data shows that while the number of shops closing has remained relatively constant over the last six years – averaging 5,700 each year – the number of new shop openings has steadily declined over that period – from 5,662 in 2013 to 3,372 last year.

While capital values have been declining in the retail sector for some time, the concern now is that capital growth in the office and industrial sectors, where the rate of growth has been slowing for over a year, turns negative. Such a scenario is already factored in to the share prices of many listed property companies and real estate investment trusts. Although take up and investment has remained fairly resilient, any such widespread value declines could have a significant detrimental impact on the current positive sentiment that the commercial property market is enjoying.

Central London Offices

The City and West End office markets experienced contrasting fortunes in the first quarter of 2019. While the City market recorded a particularly strong quarter in terms of investment turnover, Q1 take up was the weakest for six years. The West End was a mirror image with Q1 investment weak but take up very strong.

Despite these mixed results, it is fair to say that both investment and occupier markets are performing much better than could have been expected given the hiatus over Brexit and the ensuing economic policy vacuum.

Although City investment increased by over 50% versus the equivalent quarter of 2018, to £1.69bn, two thirds of that total was accounted for by the purchase by the occupier of Citigroup’s Canada Square office for £1.1bn. That aside, both the number and size of transactions is were down in the quarter. Citigroup’s purchase was no doubt a decision made in the light of changing accounting regulations which came in force this January.

By contrast, the West End had its quietest first quarter in terms of transactions for 10 years with a total of only £900m which was down roughly 25% on the same quarter last year.

In terms of occupier take up in Q1, both markets recorded similar figures of 1.2m sq ft. That represented a 20% fall in City take up from 2018, but was the highest first quarter take up in the West End for six years and 30% above the long term average. What was consistent across both markets was the small size of the average letting – 11,400 sq ft in the City and 12,200 sq ft in the West End.

According to MSCI’s Quarterly Index, average capital values continued to grow, albeit slowly, in the West End. Q1’s average growth of 0.23% brought the running 12 month capital growth to 3.9%. By contrast, average City offices slipped 0.19% in Q1 – the first fall there in values since 2016 – although growth in the last 12 months remained positive at 2.3%. The trend in both sub markets, however, is distinctly downwards.

Savills’ prime yields ticked in both market over the quarter. That in the City moved up to 4.25% while that in the West End increased to 3.75%. The 50 bp differential is the smallest in three years after narrowing from 75 bps.

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

Research Author: Stewart Cowe 13/05/2019


Property Week Press Article

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Trade Brands Buck Retail Slump
By Nick Hughes Thu 11 April 2019


When Cordatus Property Trust paid £3m to acquire a Selco Trade Centre unit in Wythenshawe, Manchester, in March, it was yet another signal of the long-term confidence investors have in the prospects for the trade counters market.

Investor appetite: Cordatus recently acquired this Selco Trade Centre unit in Wythenshawe, Manchester, for £3m

While many consumer-facing retailers face a battle to stay in the black in the face of seismic structural shifts in the sector, for those servicing the trade it is a very different story.

Announcing an otherwise disappointing set of full-year results in March, B&Q owner Kingfisher was buoyed by the performance of its Screwfix brand, whose sales shot up by 10% to more than £1.6bn.

With tradespeople continuing to favour visiting a store on their way to a job, experts agree that trade brands are less exposed than other bricks-and-mortar retailers to the threat of ecommerce. “Most [brands] have a multi-channel approach with extended trading hours, improved stock levels, quick ordering and delivery. Our main clients are not being affected by online activity,” says Philip MacLauchlan, managing director at Adept Consultancy, which is the retained agent for Toolstation.

Like Screwfix, other major UK brands such as Toolstation and Howdens Joinery are delivering strong financial results, making the parks they are located on an attractive proposition for investors.

“We still have a reasonable exposure to trade park income, which we are happy with,” says Bill Page, business space research manager at LGIM Real Assets (LGIM RA). “There are long-term structural attributes that support the sector, in particular a trend in the economy for people to pay someone else rather than do it themselves; fragmentation of construction supply chains, meaning more points of purchase; the fundamental long-term need for more housing and infrastructure in this country; and more sadly but importantly, climate change, meaning more mitigation, upkeep and maintenance.”

“There are long-term structural attributes that support the sector” Bill Page, LGIM Real Assets

Despite concerns surrounding Brexit, the positive occupier market has ensured investor demand exists for both solus units and multi-let schemes, according to Charles Howard, partner in the business space investment agency team at Cushman & Wakefield.

“Solus units are often occupied by the larger, more dominant trade operators such as Travis Perkins and Selco, where stronger balance sheets drive investor demand, particularly those with longer leases in dominant or established locations or where few competitors and multiple chimney pots exist,” says Howard.

Meanwhile, multi-let trade counter assets “offer investors similar income risk diversity and a greater opportunity to crystallise rental growth”, he adds.

Value-add initiatives

None of this is to suggest that owning a trade park is a licence to print money. With investment demand strong and yields contracting in line with the wider industrial market, landlords are increasingly looking to boost returns through value-add initiatives.

The main way to achieve capital value growth is through rental growth, explains Montagu Evans partner Steven McDonald. “A good example if a trade park is fully let would be to identify demand and speak to tenants about agreeing to surrender their lease – and look at off-market deals where you can create a higher level of rental value.”

McDonald gives the example of Sydenham industrial estate in London, where occupiers include Howdens and Screwfix and the average rental value from 2016-17 was £13.50/sq ft.

“The estate was fully let but one of the occupiers wanted to relocate to bigger premises. We had the market knowledge that Crown Paints had a requirement for Sydenham, so without having to put the unit on the market, we agreed terms with Crown Paints at £17.50/sq ft.”

Because of its circumstantial nature, tenant engineering via lease surrender and off-market deals will not always be a viable means of increasing income for investors. Page points out that many trade estates that are well let and well managed will be fully rented, in which case there may be limited opportunity to push rents. However, he adds that in certain cases multi-let industrial estates will have opportunities to convert some units to trade counters.

“When you have a void, if you get a trade counter occupier in you often find they are prepared to pay higher rent, particularly where the unit has a good road frontage enabling branding,” says LGIM RA’s Page.

Another way of diversifying and increasing income is by adding new services. McDonald highlights a growing trend for landlords to bring in convenience food brands such as Greggs to trade estates.

“Modern trade parks that are low density will throw up situations where it is possible to build a convenience retail food pod on the site,” he says. “With units ranging from just 1,500 sq ft to 1,800 sq ft, it’s a way for landlords to achieve more rental income and to provide typical trade customers, as well as members of the public, with an attractive service.”

Critical mass

Greggs, McDonald’s, Costa, Starbucks and Subway are brands that are regularly represented.“It makes sense for these brands because trade parks, and often the wider industrial and business parks, create their own catchment and customer base, making these operations highly justifiable from a sequential test point of view,” says Alfred Bartlett, head of the retail and leisure group at Rapleys.

Bartlett stresses the importance of getting a critical mass of trade brands in place before you can pull in other operators to make the site a destination. “The drive-thru or other food-to-go is often the icing on the cake and the likes of Subway et al will also judge the location not only on the trade park custom base, but on the transient trade that the prominent location affords.”

With trade rents typically top of the market in terms of the industrial sector, it is no surprise investors are sweet on trade counters. In addition to its purchase of the Selco unit in Manchester, Cordatus Property Trust recently acquired the Mercor portfolio of 33 Travis Perkins trade counter units for £45.4m.

At the time, the trust’s director Michael Cunningham said the acquisition offered “very attractive, long-term value” and provided “an opportunity for us to deploy our specialist skills to manage, re-gear and potentially redevelop the assets in line with our strategy of delivering an attractive income return to our investors with potential for capital growth”.

Six months on, Cunningham remains buoyant about the prospects for the trade counters sector. “We feel trade counters have the potential to benefit from the continued rental growth forecast in the wider UK industrial market,” he says, adding that in the longer term, Cordatus sees the opportunity to redevelop some sites for alternative uses and increase building density at others.

For landlords, sweating their existing trade counter assets is becoming increasingly important given the current imbalance between supply and demand, as McDonald explains. “Fundamentally, there remains a shortage of good-quality stock,” he says. “There tends to be a focus on London but the reality is it’s much the same throughout the UK. There’s still a shortage of new-builds and modern stock, so the overall vacancy position is very low.”

In the Greater London area in particular, a shortage of industrial space is forcing trade counter operators into competition with other industrial and retail occupiers.

“I deal with an estate in Bermondsey and the trade occupiers there are competing with fresh food suppliers who are looking for that last-mile delivery to central London,” says McDonald, who notes that businesses supplying to restaurants in central London can pass on price increases more readily than trade brands that have to be mindful of their national pricing policies.

The national shortage of stock comes at a time when the largest trade brands are actively seeking to open new outlets. Screwfix has added nearly 300 UK outlets over the past five years and has increased its target for total UK stores from 700 to 800 in 2019.

Rival Toolstation opened 40 new branches in 2018, taking its total to more than 300, and MacLauchlan notes it has a current requirement for small-format trade counters of 2,700 sq ft-plus and standard trade counters of 3,800 to 6,000 sq ft. Howdens, meanwhile, sees the opportunity for around 850 UK depots, up from the 694 operating at the end of 2018.

Acquisitive occupiers – coupled with a shortage of traditional stock – have meant that, in London in particular, some trade operators have sought to take advantage of the increasing amount of vacant high street retail units. “Brands like Screwfix are acquiring retail premises and high street units and tapping into the growth of the online retail market with a view to expanding their click and collect services, almost along an Argos-style model,” says Rapleys’ Bartlett.

Toolstation is also hunting for high street sites of between 4,000 sq ft and 5,000 sq ft, according to MacLauchlan.

Occupiers that find the right location are often prepared to pay a premium for it and take a longer-term lease. “Although it remains the case that a 10-year term with a break at five is still the most common, as supply continues to reduce and demand holds up, we are definitely seeing more instances of straight 10-year leases and there are occupiers now that will take 15 with a break of 10,” says McDonald.

Income security

This kind of long-term security of income from national operators with a strong covenant only serves to strengthen the appeal of the sector for investors.

“We continue to like long-dated income with fixed uplifts,” says Cordatus Property Trust’s Cunningham. “We have a couple of hotels in the portfolio that deliver these characteristics, as well as our trade counter assets, and we would look to add assets that can deliver this if pricing is sensible.”

Page says LGIM is similarly happy with its exposure to a sector whose prospects appear bright. “If you look at the likes of Travis Perkins, where they have been doing less well is on the more consumer-facing side and where they continue to do well is in the trade-focused side of the business. Their results are confirming our positive view of the trade sector.”

Looking further ahead, trade schemes may become more of a destination for customers in a similar way as shopping centres have adapted their offer, according to Harry Gibson, senior surveyor in the London and South East industrial agency team at Cushman & Wakefield.

“Trade counter operators will evolve to consumer demand but the landlord will also have to evolve, with a focus on improving their schemes to keep them modern and an attractive location for occupiers and their customers.”

For many landlords, this evolution has already begun.


Ben Copithorne
Corporate and B2B Communications
T: +44 (0) 207 636 7366