Forget The Opinions, This Is What The Data Says About Where UK Property Is Heading

Yesterday Prime Minister Boris Johnson launched his latest proposals for a Brexit deal with the European Union. After three years of largely fruitless debate, and three months of unpredictable Johnson premiership, this may, or may not, change anything. Nobody is betting a bean.

That’s because the UK is in a very strange place. Politics is mad, the future is uncertain, and most indicators are pointing the wrong way. Even boomtowns like Manchester are feeling the first autumn chills, and the risk that the economy is approaching stall-speed is hard to discount.

Brexit, the risk/fear of a far-left government led by Labour’s Jeremy Corbyn, and the cyclical slowdown which is now overdue, are combining to provide powerful headwinds. Add the aggravating storms of a slowdown in the U.S., a global trade war, a potential real war between Iran and Saudi Arabia, and the risk to London-bound capital flows from dramatic events in China and Hong Kong, and you’d have to have cojones of steel not to feel apprehensive. Strap in, it’s going to be a bumpy ride.

Meanwhile UK gross domestic product growth is slowing, from an anaemic 0.6% growth in Q1 2019 to -0.2% in Q2. Data published yesterday by IHS Markit/CIPS showed construction output falling to its lowest level since April 2009 (one of the worst recession years), with the commercial sector leading the way down. You can already hear the economic gears juddering.

So as the UK drives into the storm, what does the best analysis tell us about the likely impacts on values in the property sector? Who is going to make money, and who is going to see their real estate assets slide?

Retail In The Chill Zone

Drawing up a heat-map, or more correctly a chill-map, of the UK sectors and locations most vulnerable to a sudden economic breakdown involves some data, some analysis and some guesswork.

The hard number-crunching by the Investment Property Forum leaves no room for doubt about the retail sector’s place on our chill-map. It is stone cold.

Looking at the five-year capital value growth prospects, the Investment Property Forum said the annualised growth rates for the three retail submarkets lie between -2.7% for standard retail and -5.7% for shopping centres, with retail warehouses being –3.9%. Combining the analysis from the 25 investors and consultants that provide forecasts shows shopping centres continue to attract both the weakest average projections, with 21 of 25 forecasts predicting double-digit negative growth in 2019.

The good news, if there is any, is that the retail sector has suffered so much it is beyond feeling additional pain from any looming autumn macroeconomic storms, Savills Head of UK and European Commercial Property Research Mat Oakley said.

“Retail is an almost universally negative story, but that doesn’t have anything to do with Brexit or Corbyn, and it is debatable whether it could actually get worse,” Oakley said.

“MSCI data shows retail rents, across the board, down about 4% in the last 12 months. Our data shows them down about 33% because we’ve not got the valuation lag to take into account. That sounds horrific but it raises questions about how this will wash through retailers’ balance sheets in the next three to five years."

By 2023 rents may be down by 20% to 30%, which will be substantially positive for retailer profitability, and will also bring some retail locations back into play, Oakley said. "And we may find that in those retail locations that are now delivering what shoppers want, the drop in values may be closer to the bottom than many observers suspect."

Brexit shocks might deliver a few extra wobbles, particularly if shoppers in the South respond to economic uncertainty by saving (shoppers in the cheerful live-for-today North are more likely to spend regardless).

If you’re looking for some less chilly indicators (tepid spots?) Oakley points to London retail, and long-dated income on dull convenience stores and supermarkets. Elsewhere, expect more downward corrections in value.

Flexible Friends Flex Downward

WeWork's decision to pull what had become a confidence-sapping initial public offering crystalised some long-held fears about the solidity of the flexible workspace sector.

Investment Property Forum data confirms the hunches of most observers: London offices look fairly solid. Regional offices are rather less obviously strong performers, with muted rental and capital growth, but even here returns are positive and rising over the next five years.

By 2022, the office value growth rate is expected to exceed that of industrials (at 1.9% versus 1.6%), as the latter is expected to weaken, from 3% in the current year to 1.5% in 2023.

The risk of a Corby-led government does little to alter the generally upbeat tone, not least because most analysts rate that risk very low. The latest YouGov poll, published on 2 October, explains why: Labour slipped into third place behind the Liberal Democrats.

The risk that the instabilities in the flexible workspace sector revealed by the WeWork IPO extends into a more serious disruption of the office market is rated low.

“If you’d asked me a few weeks ago, I might have said WeWork and its peers would continue to boost regional office takeup," Oakley said. "Now I’d say takeup will be slower from that sector, and we might not get the two or three years of rapid expansion we’d expected. That takes some of the heat out of the market, and poses no risk.”

Regions Of Uncertainty

Dividing the UK by regions, rather than sectors, provides a slightly different perspective. It is one to cheer the hearts of Mancunians, Midland shed developers and Londoners, but does not offer quite so much to everyone else.

IHS Markit Associate Director of Economic Indices Tim Moore works on its regional purchase managers index data, one of the key leading indicators of regional economic performance.

"Regional performance reflects local specialisms, which in turn affect outcomes both positively and negatively, so there is variation, but the fact is it is hard for any region to escape gravity, and they will get pulled the same way as everyone else," Moore said.

However, one region shows some modest anti-gravitational capacities, and that is the North West. The region has exceeded the equivalent UK-wide PMI figure in each of the past six months. "Regional variations do matter, and the North West is an outperformer," he said. And historically, economic performance is a good indicator of how commercial property will fare.

The difficulty with judging regional variations when it comes to property is that transparent, agreed, moderated data is hard to come by. “The problem we have is a lack of granularity in the figures, which is a shame because there are clear differences in the dynamics in different regions, whether that is the South East versus the rest, or the big six regional centres,” IPF Research Director Pam Craddock said.

“What we can see is some evidence of capital flows heading disproportionately to these destinations, and to the Midlands Golden Triangle for logistics. But more data would be useful.”

In short, values in the UK regions are something that cannot be easily or neatly summed up: Variations across sectors and locations can be enormous. Local knowledge is the only real guide.

Boris Johnson's latest Brexit plan got a severe hammering from analysts in the few hours after it was published. "Worse than a no-deal Brexit," said one Irish commentator.

The UK is only just beginning its October journey into the unknown. Unfortunately, determining the likely impact on property values is as deeply uncertain as everything else in the UK this autumn.