The travails of the retail sector has been one of the most talked about features of the UK economy since the financial crash. Regular articles in the trade press and the national and local dailies and weeklies are full of the ‘high street’ woes but how deep are the problems and is conventional retailing in terminal decline, or are these issues merely temporary with better times ahead?
Perhaps it is just as well that the House of Commons is now in recess for the last few months have been as bad for the government as could be imagined. Attempting to chart a course towards Brexit has proven even more challenging than expected, particularly given the government’s slim majority, with any hopes of consensus following a Chequers think tank lasting all but one day before the Brexit Secretary resigned, quickly being followed by the Foreign Secretary, both of whom declaring that they could not accept the Prime Minister’s vision of the way ahead.
It went right to the wire but finally the UK and the EU agreed the so-called divorce issues in December, allowing discussions to move on to what is likely to be even more contentious, that of the future relations between the two, including transition arrangements. The UK is hopeful of having these transition arrangements agreed by March, but that may be rather optimistic given the rather slow pace of negotiations so far. Only after these transition arrangement have been agreed will debate move on to trade talks between the two after Britain’s formal departure. It is impossible to second guess how these negotiations will proceed: the UK government unwilling at present to show its hand.
The Cordatus Property Trust is a programmatic venture between CBRE Global Investment Partners (CBRE GIP) and Cordatus Real Estate (Cordatus). Cordatus purchased the hotel at Rotary Way, Gosforth, from Compass Estate Co (a private syndicate) paying £4,650,000. The price reflects a net initial yield of approximately 5.25%.
It seems that the stances of Britain and the EU are still poles apart, and that is just on the matter of settling the UK’s “divorce” payment. It appears that there has been little, if any, discussion on the future trade positions of both parties – the EU’s chief negotiator, Michel Barnier, stating quite clearly that he is not willing to move on to trade talks until the financial settlement has been agreed. Meanwhile the clock on Britain’s exit is ticking and it is looking more certain that a transition deal will be necessary, possibly one lasting two years.
When Prime Minister Theresa May called the snap general election, expectations then were for the Conservatives to greatly increase their parliamentary majority which in turn would strengthen the government’s negotiating position with the European Union.
No sooner had Prime Minister Theresa May signed Article 50, which formally triggered the UK’s exit process from the EU than she called a snap general election for 8 June. Sterling’s response to the news was positive as markets focussed on the likelihood of a large Conservative majority after the poll.
Recent opinion polls are certainly indicating a large majority – in excess of 100 – as May’s personal rating remains high, which contrasts with the weak showing of the opposition. Whether this expected larger Conservative majority indicates a shift of policy towards a ‘softer’ Brexit, which has been suggested, will only emerge during future negotiations.
From an economic point of view, the timing of the election could be good news for the Government. The year has started on a noticeably weaker footing with the first estimate of growth for the January to March quarter coming in at a disappointing 0.3% (compared to 0.7% for the previous quarter). Q1 was particularly badly hit by a marked slowing in retail sales as inflationary pressures in the economy built up.
Despite the weak start to the year, more recent survey data from the UK indicates a slightly better second quarter and more in line with previous quarters. A relatively upbeat showing from the eurozone in the new year, by contrast, has given the bloc some positive news, particularly helpful in its future negotiations with Britain.
2016 was a year of significant change characterised by the rise of anti-establishment protests and though the final three months of the year signalled a recovery in growth across many economies, the yearly outcome for global growth, at 3.1%, disappointed and was the lowest outcome since the recession hit 2009.
However, with relatively buoyant financial markets and the long awaited cyclical recovery in both trade and manufacturing seemingly now underway, momentum should push this year’s global growth to 3.5%. That rate of growth remains relatively pedestrian compared to growth rates prior to the financial crash. Much of the higher growth this year emanates from the developing economies where the outlook for commodity exporters has improved.
Since the US election, the belief that fiscal policy would be loosened has contributed to a strengthening dollar and to higher Treasury interest rates. Importantly, market sentiment has been strong. Inflation, too, has been higher than anticipated across the globe as a result of higher commodity prices, but core inflation remains subdued.
The fragility of the US economy was once again laid bare when first quarter growth came in at a very disappointing 0.7% annualised, less than half that anticipated. Commentators believe this slowdown will be only temporary.
We believe that risks to our forecasts remain skewed to the downside, particularly over the medium term. Conversely, the buoyant financial markets sentiment suggests that there is more upside potential than previously. Further out, downside risk has increased somewhat. The financial policy support, in the US and China specifically, but in Europe as well, will need to be unwound or reversed at some point. Additionally, risks come from an increased chance of protectionism, leading to lower cross-border trade, the possibility of a more rapid rise in US interest rates and financial tightening in emerging economies.
The EU economy
In line with our overall belief that there will be a stronger rebound in the advanced economies, we have increased slightly our economic forecast for the Eurozone for 2017. Much of this improvement for Europe is based on a cyclical recovery in global manufacturing and trade that began in the second half of 2016. Despite this notable and welcome improvement, our forecast has only been increased by 10 basis points, to 1.7% this year, highlighting once again the challenges facing the single currency bloc.
This optimism about the strength of the Eurozone economy was matched by comments from the head of the European Central Bank, Mario Gradhi, who said that the zone’s economic recovery was becoming “increasingly solid”. It will be noted, however, that despite this greater optimism, economic growth forecasts for the next few years remain distinctly modest by historic comparison. Of greater concern to policymakers is the increase in inflation in recent months. Inflation in the Eurozone hit 1.9% in April, in line with the ECB’s target of ‘below, but close to’ 2%. Inflation at present levels is not sufficient to force up interest rates, but policymakers will be scrutinising future rates of inflation, and rates of economic growth for guidance. Already, the ECB has cut its bond repurchasing scheme and a further reduction could be sanctioned if the Eurozone’s economic recovery continues.
Economic sentiment across the Eurozone rose to a ten-year high during the quarter, while the overall unemployment rate has continued to fall and now stands at its lowest level since May 2007. But in a reminder that economic recovery cannot be taken for granted, the news that France’s economy grew by an underwhelming 0.3% in Q1, down from the previous quarter’s 0.5%, highlights the fragile nature of this recovery. The slowdown was partly down to poor consumer spending owing to unseasonably warm weather in the quarter.
The UK economy
After defying widespread predictions that the UK economy would suffer a marked slowdown post the historic Brexit referendum, signs are finally emerging that the previously buoyant activity is beginning to falter. The first estimate of growth in the January to March quarter came in at 0.3%, weaker than expected and significantly below the 0.7% recorded in the previous quarter. While the winter quarter is always liable to disappoint because of adverse weather, statisticians placed the current weakness firmly in the slowdown in consumer spending as higher inflation put the brakes on retail sales. Inflation globally has been ticking up for the best part of a year as improved corporate optimism has fuelled a boom in commodities which in turn has pushed up commodity prices. Add to that the sharp depreciation in sterling since the referendum, then it is easy to see how the consumer price inflation in the UK has risen to 2.3%, ahead of the Bank of England’s 2% target and the highest rate for more than three years.
Sterling’s decline, however, had given a boost to UK manufacturing where survey data shows the sector to be growing at its fastest pace for three years. New orders in April hit the highest levels since January 2014, helped not only by the lower value of the pound, but by better global economic conditions. This has led to ‘solid growth in new export business’ but also to a steady increase in new domestic orders.
The forthcoming general election will certainly add to the degree of uncertainty surrounding the likely growth of the economy in the short term and while opinion polls suggest that the Conservatives will return to power with a greater majority, it is unclear at present how the composition of the parliament will influence the negotiations with Europe.
We believe that the slowdown over Q1 will only be temporary and that the economy will recover its poise over the summer months. However, with global economies having entered unchartered territory in recent months – the Brexit vote, Trump’s election as President and the increasingly hostile tensions with North Korea – risks to our forecasts remain highly skewed to the downside.
Property investment across the UK remained resilient over Q1 2017 with the reduction of major domestic investors being counterbalanced by the continued interest of overseas players who accounted for slightly more than 50% of all property deals in the UK in the quarter. Offices made up the bulk of transactions in the quarter, while there were several chunky student accommodation deals. Retail deals were few and far between. It is noticeable that, although quarterly transaction volumes have remained steady at around £10bn – £11bn over recent quarters, the number of deals has declined, indicating an increase in the average lot size. This in turn has increasingly resulted in premium prices being paid for ‘trophy’ assets, these buyers often coming from abroad. The highlight of the quarter was the announcement by British Land of the agreed sale of its joint venture with Canada’s Oxford Properties – London’s tallest office property, formally known as the Leadenhall building (but more commonly referred to as the ‘Cheesegrater’) – to Chinese investors for £1.15bn, 26% ahead of its recent valuation.
Far eastern investors are still major players in UK commercial property but the recovery of the oil price has also contributed to a welcome return of middle east investors while there has been a notable increase in continental European purchasers. Such investors are seemingly paying little heed to the consequences of a hard Brexit or to risks associated with forthcoming elections in both the UK and in the continent.
Expectations in the market for rental and capital growth and total returns remain subdued. The IPF Consensus Forecasts published in November anticipated total returns for 2016 as a whole, of 0.6%. That forecast undershot the actual returns by 3 percentage points and we believe that the forecasts for 2017 are similarly pessimistic. According to the most recent IPF Consensus Forecasts, published in February, total returns for the market this year are expected to come in at only 1.3%. Already, total returns for the first three months have recorded 2.3% (Source: MSCI/IPD Monthly Index). While some weakening of the market is to be expected as details of the Brexit negotiations unfold, property valuations do have yield support, particularly as 10-year gilt yields have moved back below 1%. Sterling depreciation has made British assets cheap. With Europe still treading water, in property terms if not economically, and huge risks surrounding US policy, UK commercial property is likely still to be the market of choice for overseas investors, particularly with its steady and secure income.
Central London offices
Turnover has remained relatively buoyant over the first few months of 2017. Quarterly transactions in the West End, at £1.89bn, was the second highest ever recorded in the first quarter (beaten only by the equivalent quarter of 2016) while City transactions were broadly similar to 2016’s total which was the largest traded since Q1 2007. A feature of the central London office market this year has been how large many of the transactions have been.
As well as these resilient turnover figures, there has been a sustained interest from overseas investors, particularly from Asia. Asian purchasers made up almost half of the purchasers in the West End and two-thirds of purchasers in the City in Q1. Notably, their interest focussed on large properties; the average lot sizes of properties purchased by Asian investors in the City being £153m. In contrast, UK institutional investment in London offices has been harder to spot. There have been no purchasers yet in the West End while they have accounted for only 13% of City purchasers. However, their focus has mainly been on reducing their central London office portfolios.
Take up of space remains resilient. Tenant take up in the West End, at just over 1m sq ft was similar to that recorded in Q1 2016 while take up in the City totalled almost 1.5m sq ft, down 11% on the previous year. Both take up figures, though, were significantly higher than the long term averages. It was noticeable that the City fringe accounted for a higher percentage of take up in the quarter than the City core, a reflection of the relative scarcity of suitable product in the core.
Despite these favourable take up figures, the vacancy rate remained at 3.8% in the West End and increased to 5.5% in the City – a rise of 25% from that recorded in the City 12 months previously. Supply now exceeds 4.6m sq ft in the West End and 6.8m sq ft in the City, in both cases, over 1m sq ft higher than at the equivalent period last year.
A record rent for the West End of £190 per square foot (psf) was hit in St James Square when the Canadian company SHL took 4,000 sq ft on a ten-year lease. That deal boosted the average prime rent in the West End to £122 psf, 11% ahead of the average over 2016. Even without that deal, average prime rents in the quarter were above that of 2016. By contrast, City rents dipped slightly in Q1, where the average prime rent recorded in Q1 fell to £72 psf from the £77 psf mark of last year. Rent free periods also lengthened – a ten-year lease now coming with 22-months rent free period (the longest since Q3 2013) in the City and 19-months in the West End. Both periods are two months longer than those at the end of 2016.
Prime yields were unchanged over the quarter at 4% in the City and 3.25% in the West End.
All statistics from Savills Stewart Cowe May 2017
The Following article appeared in the Estates Gazette:
Waiting for a Call
An imbalance in perceived values of UK shopping centres by both buyers and sellers means that deals could be few and far between this year…
“I’m wondering what a lot of investment agents are doing at the moment,” says Sovereign Centros chief executive and former Strutt & Parker investment agent Chris Geaves, while pondering the question of how many shopping centres might change hands in 2017.
“There will need to be a lot more ingenuity in bringing schemes to market – the days of waiting for brochures to land on desks are over,” he adds. The image of collective agent thumb-twiddling may not be that far-fetched. Research from Knight Frank shows UK shopping centre investment volumes barely topped £3bn in 2016 (see chart) and not even the most optimistic agent is forecasting more for the coming year. “There has been a big reduction in private equity players as the perception of future inward yield shift has gone,” says Knight Frank partner Charlie Barke. In other words, don’t expect to see Aldi/Lidl length queues to the checkout for shopping centres, at least in the first half of this year.
The least likely buyers are UK institutions (see panel). Barke believes they will be back in the game for malls by the end of the decade, but right now are “low on the shopping list”.Most likely to be heading towards the tills are overseas buyers. “We are increasingly seeing more coming from continental Europe, like German open-ended funds, as well as US players via asset management platforms,” says JLL head of UK retail investment Fraser Bowen.
A question mark hangs over local authorities – the surprise buyers of 2016. Suggestions that their activity will decrease this year are premature, says BNP Paribas Real Estate head of shopping centre investment Stuart Cunliffe, who points out that such deals often allow the public sector to drive urban regeneration plans forward. “As long as interest rates remain low and retail is expensive and difficult to develop, local authorities will want to be involved,” he says. In terms of product, buyers will be drawn to prime and super-prime centres. “These come up so rarely, there is no rationale for prices softening,” says James Findlater, head of shopping centre investment at Colliers International.
At the other end of the scale, district centres are attracting some interest (see box). Barry O’Donnell, head of shopping centre investment at Cushman & Wakefield, says: “There are ‘good secondary’ centres that have a future.” The centres most likely to suffer from tumbleweed years are those in the middle ground. While agreeing that prime assets will remain the target of investors, Savills associate director Toby Ogilvie-Smals says: “That chunk of the market [secondary non-dominant centres that need significant capital expenditure] is sliding down a slippery slope towards the cliff edge.”
So, will the agents have much to do in 2017? Strutt &Parker partner Gavin Hendry is sanguine. He says: “We will continue advising and creating deals that may or may not come through. There are 20 to 30 schemes which could come to market tomorrow, if there wasn’t an imbalance in pricing.”
RETAIL & LEISURE INVESTMENT
Investor insight: CORDATUS REAL ESTATE
UK fund manager – Niche fund management company Cordatus has recentlybought assets in Whitley Bay,Tyne & Wear, and Bingley, West Yorkshire, for the initial £150m round of the Cordatus Property Trust – and expects to do more of the same. “Our plan is to invest in lot sizes of £3m-£15m and deliberately fly under the radar of the big companies,” says director Gavin Munn. “Those smaller lots sizes tend to give better returns.” The downside of smaller centres can be a plethora of small tenants to manage, though even here there are silver linings. “Annual rents are only around £20,000-£30,000, so if there is a void, someone is likely to be able to fill it easily,” says Munn.
One of the big attractions of small district centres is that they are resilient to economic change. Shoppers come for essentials that they are unlikely to buy online, possibly two or three times per week, rather than a large single shop. For this reason Cordatus places neighbourhood centres at the low end of the risk spectrum. “Yield compression is likely to be limited, so we are looking at income, though growth won’t be dramatic,” says Munn.
Unlike Capital & Regional, Cordatus is likely to be looking anywhere in the UK apart from the South East for its future district centre purchases. “We are very happy looking where others aren’t,” says Munn.
Article written by Mark Simmons of EG
Cordatus Property Trust has Joined GRESB, the Global Real Estate Organisation.
GRESB is an investor-driven organization that is transforming the way environmental, social and governance (ESG) performance of real assets are assessed globally, including real estate portfolios and infrastructure assets.
The following piece appeared in the new members section of the GRESB newsletter, click on link at bottom for more information on GRESB:
Cordatus Property Trust | “The Cordatus Property Trust decided to become a GRESB Real Estate Fund Manager member as the ability to demonstrate and benchmark ESG performance of property companies and property funds is becoming ever more important and relevant in today’s investment world. GRESB is widely recognized as the global benchmark for ESG assessment of real estate portfolios and by our participation, we will be able to easily communicate with our investors on ESG performance using a clear, consistent and recognized framework.”