The Economist: Occupier market resilience but challenges ahead
Political uncertainty does not stop with the US and the UK. We have a referendum in Italy and a re-run of the Austrian Presidential Election in early December, both of which are expected to produce ”anti-establishment” results. And that’s before the big three of the Dutch, French and German General Elections that will take place in 2017. No doubt these elections will produce a few bouts of nervousness but, at the end of the day, it is unlikely that there will be a major change in the governments of the big EU countries, although political continuity in Italy will remain at risk.
For now though it is the US that is at centre stage. Inflation expectations and bond yields have risen in the US and elsewhere but we need to retain a sense of perspective (as my financier colleague points out). Neither can we take for granted that where the US leads, Europe will follow.
'Reaganomics’ in the early 80’s (which ‘Trumponomics’ is expected to resemble in many ways) saw a sharp gap open up between US and European bond yields and there is every reason to expect a re-run, especially with unemployment in much of the Euro area is still running at more than 10 per cent.
Back in the UK, the economy is showing notably few adverse effects from the referendum. Q3 GDP was up 0.5 per cent, a little slower than the 0.7 per cent recorded for Q2 but not disastrously so. Business surveys have recovered to pre-referendum levels and employment is still growing (although there has been a small up-tick in the Claimant Count Unemployment measure). Most remarkably, retail sales volumes are booming – up nearly 6 per cent over the year (3 month averages). Much of this is e-commerce driven but there was still enough left over to produce a healthy 3 per cent growth for bricks and mortar stores. Few think that the current robust state of the economy will survive the ongoing tides of uncertainty unscathed in 2017 but the consensus view on economic growth in 2017 has been steadily rising from around 0.7 per cent after the referendum to 1.1per cent now.
Since the referendum, rental growth has actually accelerated in retail (CBRE Monthly Index) but has stalled in Central London and has slowed considerably for offices outside of London. Industrial and logistics rents appear unaffected and are now clearly the fastest growing rents of any sector.
There will be challenges to occupier markets ahead. Retail may become more polarised as inflation and unemployment creep up. Sentiment in the London occupier market will wax and wane with political developments and the success, or otherwise, in winning or holding onto major tech or financial services occupiers (recent successes in the tech area have been a major boost to confidence). Regional markets are not disconnected from London but government and other pre-planned re-locations provide some insulation. At present, only industrial and logistics rental growth looks to be really robust in the face of political and economic uncertainties due largely to the sharp up-turn in e-commerce mentioned earlier.
The Financier: Uncertainty dominates, certainty comes at a premium
We might have thought that the EU referendum changed the game, but since then the US Presidential Election has generated if anything greater uncertainty. For all that, expectations seem to be that US policy will be expansionary, possibly inflationary and consequently there are expectations of higher bond yields. That said, the much reported “bond rout” has seen 10 year buds rise to 30bp and the 10 year gilt return to its pre-referendum level, itself an all term low at the time – perhaps we need some perspective here.
In UK real estate markets, volumes have picked up after the summer’s hiatus, but the return of activity has followed the trends established since the second half of 2015, rather than forging a new channel. Across sectors, prime has demand but not much supply, secondary is less demanded but perhaps more available, and more value add stock has not found a level.
Unpacking this a step further. There is capital, especially from Asia and Europe, for high quality assets – their reasons for buying have not changed and the weaker pound is an incentive for some. What yield expansion there has been mathematically reflects reduced growth expectations. Long income is a better bid with pricing reflecting the continuing shortage of robust income sources in the investment universe. Value-add volumes are suffering from the underwriting conundrum. Even moderately extended timescales can impact the level of bids materially, given the underlying cost of capital. The absence of stress means there are few forced sellers. Consequently, the bid-offer spread remains largely uncrossed.
These patterns are mirrored in the listed markets. Real estate has underperformed as a whole, reflecting the fears of rising rates. Secure income from less cyclical sectors has outperformed the more economically exposed. Stocks exposed to Central London have fallen further with more value add and project finance type stocks falling the most.
What might change this and lead to a re-rating of the real estate stocks and a strong recovery in conviction, and hence activity in the physical market? Time is one argument. It is amazing how much uncertainty we can get used to; as the EuroZone crisis has illustrated. However, the rolling series of political events over the next year or so and with the service of an Article 50 notice and the commencement of formal Brexit negotiations to throw into the mix I struggle to see a strong effect in the short term. On the downside, a material weakening in economic performance or sentiment could push the physical markets towards the levels implied by the listed space. To date, the data has been pretty robust lengthening the odds, or at least the timescale for this scenario.