INVESTMENTBRIEFUK property investment marketSummer 2019

International Property Consultants

www.geraldeve.com

Investment Brief

• Both domestic and overseas investment activity in UK real estate lost momentum in early 2019 while Brexit-related uncertainty dominated the headlines. Quarterly investment volume in UK commercial property in Q1 was the lowest since the referendum result in Q3 2016.

• Annual total returns are undoubtedly past their mid-2018 peak and there remains a wide variation

in performance across the different segments. Industrial assets are way ahead of their office and retail counterparts, with not only stronger rental growth but also stronger positive yield impact.

• Following a few months of inactivity in the lead up to the original Brexit deadline, we have seen a revival in buyers’ appetites in Q2, although the supply of investment assets has, commensurately, also slowed given lack of vendor confidence and motivation to sell.

• There is equity to be invested, and there continues to be depth to the lending market and rates are competitive. Consequently, we anticipate greater deal volumes in H2 2019, regardless of the Brexit outcome, as more clarity ultimately emerges.

• Industrial is still forecast to outperform over the next three years. In particular there is strength in multi-let, where investors look favourably at assets that still have pent up rental growth to be realised. In contrast, retail segments are anticipated to underperform, with shopping centres particularly affected.

• Commercial property annual total return is set to fall again in 2019 to a low point of this cycle of 2.4%. Income return will partially offset expected negative capital growth that will result from yield softening across most property segments.

EXECUTIVE SUMMARY

Industrial Office

0

20

£bn

Retail Alternatives

2

4

6

8

10

12

14

16

18

Q1

2016

Q2

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q3

2017

Q4

2017

Q1

2018

Q2

2018

Q3

2018

Q4

2018

Q1

2019

UK quarterly investment volumes, by sectorSources: Gerald Eve, Property Data

3

Summer 2019

Brexit delay improves economic forecast for 2019, but uncertainty to be a drag on 2020

A stronger-than-expected Q1 led Oxford Economics to upgrade its forecast for 2019 GDP growth slightly to 1.5%. However, the extension of the Article 50 period will delay the anticipated recovery in the value of sterling, keeping inflation higher, and prolong the drag from uncertainty on business investment. As a result, the forecast for 2020 has been lowered to 1.7% from 1.9%.

After quarterly GDP growth of just 0.2% in Q4 2018, we appear set for a much firmer outturn of around 0.5% for Q1 2019. But this gives an over optimistic view of the underlying strength of the economy and is largely due to a sharp drop in output in December which was reversed in January, as well as some precautionary stockbuilding by firms preparing for a ’no-deal’ Brexit. Ultimately, the economy appears to be growing at a solid but unspectacular pace, with Q2 likely to be softer as the temporary boost from stockbuilding unwinds.

The economic forecast assumes that the government is eventually able to secure parliamentary approval for the Withdrawal Agreement, allowing the UK to leave the EU at the end of October. However, there is a risk that the parliamentary impasse will not be broken, which could lead to a further extension to the Article 50 period, probably until March 2020. There is also a significant risk of an accidental ‘no-deal’ outcome, which could happen if MPs fail to coalesce around an alternative and the EU refuses to allow any further extension.

Sustained growth in household spending power

A simultaneous pick-up in wage growth and a cooling in inflationary pressures has seen household spending power strengthen over the past six months. But momentum is likely to ebb in the near term, with the acceleration in wage growth petering out as the impact of supportive base and compositional effects fades, while the government’s welfare reforms remain a headwind. But prospects for 2020 look better, with the welfare freeze coming to an end and inflation set to resume its descent due to some recovery in the value of sterling.

The recovery in income growth in 2018 enabled households to engage in some modest rebuilding of their balance sheets, though the savings ratio remains very low. The forecast assumes that growth in spending closely tracks improvements in real incomes over the next few years, with consumer spending growing by 1.7% in 2019 and 1.6% in 2020, though quarterly growth rates will pick up steadily during next year as inflation slows.

Less restrictive fiscal stance

Oxford Economics estimates that fiscal policy exerted a one percentage point drag on economic growth in the fiscal year 2018-19. But the fiscal stance is due to become less restrictive in the coming years, with the worst of the real terms cuts to government spending now in the past.

Indeed, if an ‘orderly’ Brexit is achieved, it is possible that the Chancellor will use some of the headroom against his fiscal rules to loosen fiscal policy in the autumn Budget.

Boost to net exports fades as sterling strengthens and global growth softens

Though stronger global growth and a weak pound drove a marked pick-up in export growth in 2017, the boost from these factors faded last year. We expect world growth to weaken again in 2019 as the impact of more protectionist trade policy is seen, with growth in world trade (weighted by UK export shares) slowing from 5.2% in 2018 to 1.4% in 2019. And though the protracted uncertainty associated with a delay to Brexit is likely to keep sterling weak in the short term, an ‘orderly’ outcome should ensure that the pound recovers during 2020 given the extent to which it is currently undervalued.

Brexit uncertainty weighs on business investment

Although firms are in solid financial shape, they have been reluctant to spend, and at Q1 2019, business investment was still 2% below its late-2017 peak. Uncertainty around Brexit has been a key factor, and this is likely to persist until the UK’s future trading relationship with the EU becomes clearer. After falling 0.4% last year, we expect business investment to decline by a further 0.6% in 2019 before recovering to grow by 1.3% in 2020. Overall investment is set to be firmer, growing by 1.4% this year and then 1.7% in 2020.

UK ECONOMY

-1.0

4.0

%

-0.5

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1997-2007

2007-2017

2018 2019 2020 2021 2022

Consumer spending

Government consumption

Net trade

Investment

Other (inc inventories)

GDP growth

UK: Contributions to GDPSource: Oxford Economics

Consumer spendingGovernment consumption

Net tradeInvestment

Other (inc inventories)GDP growthAverage weekly earnings

-3

-2

-1

7

% per year

0

1

2

3

5

6

4

2004

2005

2006

2007

2008

2009

2010

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2014

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2016

2017

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2019

2020

2021

2022

2023

CPI inflation

Forecast

UK: Earnings & inflation Source: Oxford Economics

Average weekly earnings CPI

www.geraldeve.com

Investment Brief

Investors delaying decisions until the UK’s relationship with the EU becomes clearer

The uncertainty surrounding Brexit continues to have a negative impact on the investment market, with investors delaying decisions until the UK’s relationship with the EU becomes clearer. As a result, investment volume fell significantly in Q1 to £2.4bn, a 60% decrease on Q4, and 51% less than the equivalent period in 2018.

The office sector recorded a quarterly total return of 1.1% in Q1, taking annual total return to 5.8%. The sector outperformed retail’s -2.8% annual total return, but fell short of industrial assets, which recorded 13.7% annual total return.

Income continues to be the main driver behind investment performance with limited growth in capital values at this stage of the property cycle. Whilst rental values continued to grow in Q1, recording quarterly growth of 0.3%, yields softened for the first time since September 2016, generating quarterly yield impact of -0.2%. This softening in yields is expected to continue throughout 2019, and as a result, capital values are forecast to decline by 1.9% this year.

However the occupier markets remain resilient and Oxford Economics expects greater growth in office-based employment compared to other sectors over the next three years, which will help maintain the strength of the leasing market. This is expected to ultimately help support greater total returns from 2020 onwards.

London office transaction volumes fall for third consecutive quarter

Transaction volumes fell for the third consecutive quarter across central London to £1.3bn, with investors delaying decisions where possible until after 29th March. Now that Brexit has been delayed until October, investment activity is expected to increase slightly during the summer months, although uncertainty remains and overall volumes in 2019 are expected to be low. Those that are looking to buy have moved away from core assets due to the lack of potential rental growth, and instead are targeting value-add opportunities.

The hesitancy in the London investment market is largely coming from vendors, and as a result there is little stock available to buy. The transactions that did take place in Q1 2019, were mostly down to investors under some pressure to sell. There has also been a notable increase in off-market transactions, with vendors reluctant to market their assets due to a lack of confidence.

Whilst overseas investors continued to be the main buyers in Q1, the weight of capital targeting London has eased. Investors from the Far East in particular seem to have been negatively affected by the downbeat Brexit headlines. However, should sterling fall again, the perceived discount of London offices could mean they are once again targeted more aggressively.

9

6

£ billion

1

5

4

0

2

3

7

8

Q2

2018

Q3

2018

Q4

2018

Q1

2019

Q1

2018

Q4

2017

Q3

2017

Q2

2017

Q1

2017

Q4

2016

Q3

2016

Q2

2016

Q1

2016

Q4

2015

Q3

2015

LondonSouth East

Rest of UK

UK office investment volumesSources: Property Data, Gerald Eve

OFFICES

5

2

%

-4

-3

1

0

-5

-2

-1

3

4

Jun-

18

Sep

-18

Dec

-18

Mar

-19

Mar

-18

Dec

-17

Sep

17

Jun-

17

Mar

-17

Dec

-16

Sep

-16

Jun-

16

Mar

-16

Dec

-15

Sep

-15

Income returnEquivalent yield impact

Market rental value growthTotal return

UK office quarterly total returns and componentsSources: MSCI, Gerald Eve

5

Summer 2019

The occupational market remains strong with high demand for new space. This combined with a lack of good quality grade A space will lead to continued rental growth in both the West End and the City, albeit not as strong as previous years. However, yields are expected to soften over the forecast period, leading to a slight decline in capital values.

Prime and secondary yield gap widening for South East offices

Transaction volumes in the South East totalled £387m in Q1 2019, below the five year average of £575m. The majority of transactions were located in the Thames Valley region and south of the M25, which is reflective of the liquidity and attractiveness of the core town centre locations such as Brighton, Reading and Windsor.

The gap between prime and secondary yields continued to widen in Q1 2019, highlighting that investors are becoming increasingly polarised. Investors will typically target either prime core assets to capitalise on secure income, or, less frequently, value-add opportunities to drive capital and rental growth.

The South East occupational market remains resilient, with growth in headline and net effective rents evidenced across most South East markets in Q1. This was driven by buoyant occupational demand and lack of good quality grade A availability, which has been further exacerbated by residential permitted development, and, the scarcity of speculative office development.

With Brexit delayed, transaction volumes are expected to increase with £211m of South East offices under offer at the end of Q1. Activity from local authorities reduced as they entered purdah ahead of the May 2019 local elections, however we would expect overseas investors to increase their exposure to the market once we receive some certainty over Brexit.

UK institutions offset some overseas investor losses and become the most active office buyers across the regional cities

Office investment volumes outside the South East fell by 65% in Q1 to £460m, with a lack of opportunities responsible rather than any particular fall in domestic investor sentiment. Overseas transactions have fallen recently, due to the lack of available “trophy assets” on the market, which has to date been a main target. In their place, UK institutions have been the most active buyers, accounting for 36% of transactions in Q1, with the majority of sales coming from property companies.

Whilst investors remain nervous about the outcome of the Brexit negotiations, they will take comfort in the strength of the occupier market. Demand for new space remains positive across the UK’s key cities, with most suffering from a lack of grade A availability. A combination of onshoring occupiers from London and the government’s GPU deals has meant that most of the development space under construction has already been let. As a result, there’s an upward pressure on rents, which will offset some of the yield softening forecast in 2020 and 2021.

60

30

%

20

10

0

40

50

<6% 6-7% 7-9% >9%

South East office investment volume by net initial yield (Q1 2019)Source: Gerald Eve

12

6

%

-6

-4

4

2

-8

-2

0

8

10

2016 2017 2018 2019 2020 2021

Rental growthIncome return

Yield impact

Regional office performance and forecastSource: Gerald Eve

100

60

%

10

50

40

0

20

30

70

80

90Q

2 20

18

Q3

2018

Q4

2018

Q1

2019

Q1

2018

Q4

2017

Q3

2017

Q2

2017

Q1

2017

Q4

2016

Q3

2016

Q2

2016

Q1

2016

Q4

2015

Q3

2015

UK InstitutionsProperty companiesPrivate individuals

Overseas investorsOccupierFinancial / Banks

Central London investment by purchase typeSources: Property Data, Gerald Eve

www.geraldeve.com

Investment Brief

Continued negative annual total returns for UK retail property

UK retail quarterly total return fell to -1.3% in Q1 2019, taking the annual total return to -2.8%. This is the only the second time in nine years annual total return has been negative for UK retail, which is reflective of both struggling occupier markets and weak investor sentiment. Out of all the main segments, retail has consistently delivered the weakest returns and in Q1 2019 the gap between retail and other segments widened, further highlighting the sector’s underperformance.

Such a poor showing is illustrative of the impact changing consumer shopping patterns are having on retail property – internet retail sales accounted for 18.6% of all retail sales in March 2019 – but also the perception this switch has had on property investors. Rental values fell by -3.1% year-on-year, the strongest decline since 2010, and this was combined with year-on-year negative yield impact of -4.6%. This has been a consistent story across most retail segments, although shopping centres in particular recorded sharp falls in total return, ending Q1 with an annual total return of -7.3%. This segment has recorded negative annual yield impact every quarter since Q3 2016 and delivered negative annual rental growth of -3.8% in Q1 2019.

Weak occupier market leads to greater talk of ‘repurposing’ retail assets to alternative uses

Over the current market cycle there has been reduced demand for traditional ‘bricks and mortar’ retail and there have been few periods of positive growth in retail rents. Against a backdrop of retailer CVAs and administrations, it was department stores which recorded the most negative annual rental growth of all commercial property assets in Q1, at -8.3%. Such weak occupational performance is likely to lead to more redevelopment or ‘repurposing’ of department stores. Landlords are looking at ways to transform upper floors to leisure, hotel, residential, office, and even incorporate ‘last mile’ logistics on lower floors.

25

10

%

0

5

-5

15

20

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

Dec

-15

Mar

-16

Jun-

16

Sep

-16

Dec

-16

Mar

-17

Jun-

17

Sep

-17

Dec

-17

Mar

-18

Jun-

18

Sep

-18

Dec

-18

Mar

-19

All property Office

Retail industrial

All retail Shopping centre

High street Retail warehouse

Annual total returns by main property segmentSources: MSCI, Gerald Eve

20

5

%

-5

0

-10

10

15

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

Dec

-15

Mar

-16

Jun-

16

Sep

-16

Dec

-16

Mar

-17

Jun-

17

Sep

-17

Dec

-17

Mar

-18

Jun-

18

Sep

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Dec

-18

Mar

-19

4,500

3,000

Number of units

500

1,000

0

2,500

1,500

2,000

3,500

4,000

2016 2017 2018

899

895

1,428

791

1,192

1,314

1,058

1,836

1,142

Main retail segments, annual total returnSources: MSCI, Gerald Eve

DemolishedRetail to merged, split, office, residential, warehouseRemoved / other

Retail conversions – structural change to units (2016-2018)Source: Local Data Company

RETAIL

7

Summer 2019

There has been a marked difference in the returns profile geographically – with London still delivering positive returns, but nearly all other locations delivering negative ones. On a quarterly basis, standard shops in central London was one of the few retail segments (along with supermarkets) to deliver positive quarterly total returns in Q1. Tourist numbers in central London remain high and the impact of ongoing political uncertainty on Sterling has ensured a continuing influx of international visitors. Against this backdrop, and the prospect of improved transport infrastructure, retailers can arguably feel more confident to open shops, which in turn has protected the segment against the general pressures facing the broader retail market.

Trading has been thin and bidders for anything other than prime assets or value-add retail warehouses (which have the longer-term prospect for repurposing for other uses) have been limited. Large lot size transactions agreed in Q1 involved private property companies and UK institutions purchasing retail warehouses and supermarkets in London and the South East. Overall volumes traded in Q1, at just under £1bn, represent the weakest quarter for retail investment since Q1 2012, with profit-taking institutions the dominant sellers and private property companies the dominant buyers.

Continued yield expansion and further falls in rents expected

The poor performance of retail warehouses has created opportunities for some purchasers. M7 Real Estate Investment Partners’ purchase of two multi-let retail parks and three solus units at the start of 2019 for £23.9m, reflecting a net initial yield of 8%, is a good example of investors’ approach to the retail sector. At the right price, there is a defensive quality to these assets, given the value-add opportunities and prospects for long term change of use.

However, outside of central London, we expect that the retail market will continue to underperform relative to other main commercial property market segments. Reflective of ongoing trading weakness, further falls in rents across all segments outside London are expected, as is continued yield expansion. Investment markets will remain hamstrung by the gap in historic valuations and buyer’s expectations.

The investment case for the right retail stock – good catchment, well traded – at the right price, remains compelling, but landlords need to realistic on pricing. We expect that major retail landlords will continue to reposition away from the sector, and outside of London, for increased off-market activity given vendors’ general lack of confidence in the market.

Standard shop Shopping centres

Retail warehouse Dept / Variety store

Supermarket

6

0

%

4

2

10

6

8

2

4

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

Dec

-15

Mar

-16

Jun-

16

Sep

-16

Dec

-16

Mar

-17

Jun-

17

Sep

-17

Dec

-17

Mar

-18

Jun-

18

Sep

-18

Dec

-18

Mar

-19

Annual rental value growth, main retail segmentsSource: MSCI

South EastLondon

Rest of UKPortfolio

3.0

£billion

0.5

1.0

0

2.5

1.5

2.0

Q1

2016

Q2

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q3

2017

Q4

2017

Q1

2018

Q2

2018

Q3

2018

Q4

2018

Q1

2019

Regional retail investment volumesSource: Property Data

100

%

10

20

0

90

30

40

50

60

70

80

Q3

2015

Q4

2015

Q1

2016

Q2

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q3

2017

Q4

2017

Q1

2018

Q2

2018

Q3

2018

Q4

2018

Q1

2019

UK institutionsProperty companiesPrivate individuals

Overseas investorsOccupier

Retail property by purchaser typeSource: Property Data

www.geraldeve.com

Investment Brief

Occupier side strength means investor sentiment remains positive amid Brexit-related hiatus

Underlying sentiment is positive for industrial, and investors still have confidence in the occupier side of the market. Annual rental growth is past the peak from June 2018, where London multi-let hit 9% per year, but rates of growth are still historically high. Industrial rental growth sits comfortably above its office and retail counterparts, which are barely above 1% on average in the case of offices and actually falling by more than 3% in the case of retail. Within the industrial market, we can see that rental growth in the highly supply-constrained and in-demand multi-let segment is outstripping that for distribution warehousing.

Industrial rents and capital values are at record highs and there is still money to be invested. But investment demand is undoubtedly down compared to 2018, as fears of a global economic slowdown and Brexit-related uncertainty dominate the headlines. Underbidders number in the threes and fours, compared with 10 or more for similar assets at the end of 2018. Anecdotally there has been a flight to quality and reduced interest in any assets with perceived risk, whether that be covenant, lease profile or location-related risk.

Whilst there is understandable nervousness from European investors and the rate of money coming from the Far or Middle East has slowed, overseas investors were positive net investors in Q1 2019. Interest from US investors drove net overseas investment to over £400m as Exeter Property Group invested in single-let distribution warehouses and Westbrook Partners purchased the IO2 multi-let industrial portfolio. Profit-taking private property companies continue to be significant net divestors of industrial property.

5.0

2.5

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0

4.5

3.5

4.0

1.5

2.0

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£ billion

Q1

2016

Q2

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2018

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2018

Q4

2018

Q1

2019

LondonSouth East

RegionsPortfolio

Quarterly investment volumes, UK industrialSources: Property Data, Gerald Eve

10

7

%

5

6

0

3

4

2

1

8

9

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

Jun-

15

Sep

-15

Dec

-15

Mar

-16

Jun-

16

Sep

-16

Dec

-16

Mar

-17

Jun-

17

Sep

-17

Dec

-17

Mar

-18

Jun-

18

London multi-let peak at 9%

Sep

-18

Dec

-18

Mar

-19

Annual rental growth, industrial segmentsSources: MSCI, Gerald Eve

INDUSTRIAL & LOGISTICS

500

0100

-800

400

200300

-200-100

-300-400-500-600-700

£ million

Overse

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rs

Prope

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mpanie

s -

publi

c

UK insti

tution

s

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l / ot

her /

priva

te ind

ividua

ls

Prope

rty co

mpanie

s -

priva

te

Q1 2019Q4 2018

Industrial net investment volumes by investor type Sources: Property Data, Gerald Eve

All multi-let Rest of UK multi-let

London multi-let Distribution warehouse

9

Summer 2019

Investment supply has similarly fallen, with few forced sellers, supporting yields

The institutions have been active in 2019 for prime assets with long income that will ride out any medium term political and economic instability. There are also some opportunistic investors seeking value-add assets in urban infill locations. However, it has been public property companies who have been consistently in the running for industrial assets, in particular Tritax Big Box REIT for distribution warehouses and Stenprop for multi-let estates.

While buyers sit on their hands, the supply of investment assets has, commensurately, also slowed. Some private equity investors at an IRR peak have taken profits, and some selected pension funds have brought assets with open market rent reviews to the market in line with their strategy to target index-linked long income. The market is not characterised by forced sellers, though redemptions in some retail funds means that a small number of these are currently looking to sell to free up some cash.

Despite the recent investor hiatus, the overall industrial yield trend in recent years has been transformative.

In the space of two years the order has effectively reversed, mainly as a consequence of a sharp downward trend for industrial yields. Within industrial, multi-let stands out, having narrowed the gap with distribution warehousing. This has generated the very strongest capital growth and total returns in this recent cycle. London multi-let annual return hit 27.1% in June 2018, way in excess of London office and retail counterparts. The interesting point to note for Q1 2019 is that even the non-South East region for multi-let total return was above UK distribution warehousing, such has been the strong investor appetite and positive yield impact for that segment.

A period of weaker returns ahead, but continued outperformance of other property segments

Market participants suggest that core yields have held stable since the end of last year, though transactional evidence is thin outside of a handful of highly reversionary deals. In the recent flight to quality, however, good quality secondary assets and below have likely slipped around 50-75 basis points.

We anticipate greater deal volumes towards the end of 2019, regardless of the Brexit outcome, as more business certainty should start to emerge. Following a few months of inactivity in the lead up to the original Brexit deadline, we have seen a revival in investor activity in early Q2, particularly by funds and overseas investors.

Following the Brexit extension, many investors who have been on the fence for several months are now back in the market, with pent-up money to invest. The increase in off-market activity so far in Q2 will help support volumes in the coming months, but the lack of forced sellers and the return of Brexit uncertainty later this year means overall activity is expected to be down in 2019. Especially as non-core sellers are unlikely to be under any pressure to realise sub-value pricing.

In terms of pricing, in the relatively unlikely scenario of a recession in the real economy, this would dampen yields and capital values across the board, with the flight to quality meaning core yields will continue to be least affected – in part as a consequence of a further slide in the value of sterling that will provide an impetus to overseas demand. A less problematic scenario is more likely, with only pricing in non-core assets really affected. Also, the industrial property segment as a whole is relatively insulated to external events compared with the other major property segments, given the pent up rental growth yet to be realised and the ongoing positive structural shift as an asset class.

Our central forecast is for 5.6% total return in 2019 and an average annual figure of 5.3% over 2019-23.

8.0

6.5

%

5.0

6.0

5.5

7.0

7.5

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-15

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15

Sep

-15

Dec

-15

Mar

-16

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16

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Mar

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Jun-

17

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Mar

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Jun-

18

Sep

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Dec

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Mar

-19

Retail Office

Multi-let Distribution warehouse

Equivalent yields, by property segmentSources: MSCI, Gerald Eve

30

15

%

0

10

5

20

25

Mar

-14

Jun-

14

Sep

-14

Dec

-14

Mar

-13

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13

Sep

-13

Dec

-13

Mar

-15

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15

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Mar

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Sep

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Dec

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Mar

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Jun-

17

Sep

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Dec

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Mar

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Jun-

18

Sep

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Dec

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Mar

-19

London multi-let peak at 27.1%

All multi-let London multi-let

Rest of UK multi-let Distribution warehouse

Annual total return, industrial segmentsSources: MSCI, Gerald Eve

www.geraldeve.com

Investment Brief

Secure, long term income continues to attract investors

Investment volumes in alternative assets exceeded £4.9bn in Q1, accounting for 48% of all UK transactions. The sector’s characteristics for delivering well-secured long-term income with the added benefit of built in growth through indexation or fixed uplifts continue to drive investment demand. Also, the increase in alternative investment as a share of total investment partly reflects that investment in traditional sectors has been weaker. Similar levels of activity are expected throughout the year, although a lack of available stock could restrict transactions.

Despite the high volume of transactions, the investment performance of the alternative sector eased back from a relatively high point in the second half of 2018. Healthcare was the best performing segment, achieving an annual total return of 9.3% at the end of Q1 2019. The residential and leisure markets were relatively weaker, achieving annual returns of 5.4% and 4.9% respectively, whilst the hotel sector achieved an annual total return of 7.9%.

Investor sentiment for the hotel sector continues to be positive

Appetite for indexed-linked, institutional leases continues to gain momentum. This was reflected in terms of transaction volumes which reached £6.2bn over the last 12 months, an 18% increase on the previous year. The budget hotel sector remains vibrant with strong demand from investors for the Premier Inn and Travelodge covenants, but with new operators emerging almost daily.

Over the next 12 months we expect investment stock to remain constrained, but current space under construction will open this up over the medium term.

Investor demand for student accommodation remains high

The investment fundamentals for student accommodation remain positive, with international applicants driving an overall increase in student numbers year-on-year. However, there is an overall undersupply of purpose-built student accommodation across the UK, which resulted in a 36% fall in transaction volumes in 2018 to £2.6bn.

ALTERNATIVES

100

%

10

20

0

90

30

40

50

60

70

80

Q4

2015

Q3

2015

Q2

2016

Q1

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q3

2017

Q4

2017

Q1

2018

Q2

2018

Q3

2018

Q4

2018

Q1

2019

AlternativesOffice

IndustrialRetail

UK investment transactions by asset typeSources: Property Data, Gerald Eve

16.0

10.0

% annual total return

4.0

8.0

6.0

12.0

14.0

Q3

2015

Q4

2015

Q1

2016

Q2

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q3

2017

Q4

2017

Q1

2018

Q2

2018

Q3

2018

Q4

2018

Q1

2019

Residential Hotel

Healthcare Leisure

Annual total returns, by alternative asset typeSources: MSCI, Gerald Eve

11

Summer 2019

An ageing population and a glut of outdated stock provide opportunities for development and funding in the healthcare sector

In a market with low investment grade covenants and localised demand (3 to 5 miles), asset quality and operator capability remain the key drivers of demand for investors. In 2018, £1.5bn was transacted, an 18% increase on the previous year, although this fell to a more average £390 million in Q1. Investment demand for healthcare assets will remain strong throughout 2019, with the continued shortfall of care beds driving occupancy rates in many regions. We expect more corporate activity in the sector, given reports of Round Hill Capital looking to purchase stakes in HC-One, one of the largest care home providers in the UK, for £1bn.

Asset management opportunities draw in investors to the leisure sector

Within the pub sector, there are asset management opportunities available to investors willing to capitalise on underinvested properties to generate higher levels of return compared to more traditional asset classes. Consequently transaction volumes for restaurants and bars increased significantly in 2018 to over £2bn.

High transaction tax and Brexit uncertainty create significant headwinds in the residential market

A number of factors continue to challenge the residential investment market. While it may be convenient to attribute demand reductions on punitive SDLT rates and uncertainty surrounding Brexit, both of which contributed to a slowdown in prime central London and the country house market, it is important to remember that the market is cyclical and was past its peak when the higher rate SDLT was introduced. High transaction tax compounds the reduced activity in a flat or falling market. Vendors are increasingly reducing asking prices and developers are ready to offer incentives and discounts in order to secure a sale.

UK investors

16%

Propertycompanies

15% Private Individuals 1%

Occupier

4%Overseas investors

64%

Q1 2019 Alternative transactions by purchaser typeSource: Property Data

www.geraldeve.com

Investment Brief

OUTLOOK

We anticipate greater deal volumes in the second half of 2019, regardless of the Brexit outcome, as more business certainty hopefully emerges.

Commercial property annual total return is nevertheless set to fall again in both 2019 and 2020 to a low point of this cycle of just under 1%. Income return is set to partially offset expected negative capital growth that will result from yield softening across most property segments.

An easing of the very significant positive returns from the industrial segments will drive this overall trend. Nevertheless, industrial is still forecast to outperform over the next three years, with only really the non-core properties expecting much outward yield shift. In particular there is strength in multi-let, where assets still have pent up rental growth to be realised, set against an exceptionally supply-constrained backdrop.

Retail segments are anticipated to generate the lowest returns over the next three years. The ongoing consumer transition from physical shops to online sales coupled with the short term negative impact from Brexit will keep retail rental growth negative, with shopping centres particularly affected. Commensurately, investor sentiment is weakest for retail and we expect the most negative yield impact for this property segment to continue.

Offices are set to fair somewhat better than retail, though some of the more cyclical central London markets will pull down the overall office average in the short term. The South East office occupational markets should remain generally resilient, especially with the further erosion of supply through ongoing residential permitted development. This combined with the higher income return component for the South East puts it on track to outperform the City office markets over 2019-21.

13

Summer 2019

Rental Growthl Total Return

2019 2020 2021 2019/21 2019 2020 2021 2019/21

High Street -2.8 -2.8 -1.5 -2.3 -2.2 -6.4 1.3 -2.4

Shopping Centres -3.8 -3.3 -2.0 -3.0 -5.1 -3.2 2.7 -1.9

Retail Warehouses -3.3 -3.0 -1.8 -2.7 -1.1 -1.4 0.3 -0.7

West End Offices 0.2 0.6 2.2 1.0 3.9 1.4 6.1 3.8

City Offices -0.4 0.1 1.5 0.4 2.2 2.2 5.6 3.3

South East Offices 0.2 0.8 3.3 1.4 3.5 2.2 7.2 4.3

All Offices 0.8 0.9 2.8 1.5 4.3 0.4 7.2 4.0

All Industrials 3.5 3.0 2.5 3.0 5.6 4.2 4.7 4.8

Standard Industrials 4.2 3.6 2.9 3.6 7.4 5.6 5.4 6.1

Distribution Warehouses 2.0 1.5 1.4 1.6 3.1 2.8 4.9 3.6

All Property 0.0 0.1 0.8 0.3 2.4 0.6 4.3 2.4

12

%

10

-6

6

8

4

2

0

-2

-4

2016 2017 2018 2019 2020 2021

Yield impactRental growth

Income return Total return

All Property, total return and componentsSources: MSCI, Gerald Eve

7

%

5

6

-3

3

4

2

1

0

-1

-2

Standa

rd in

dustr

ial

All indu

strial

s

City of

fices

Wes

t End

offic

es

South

East o

ffices

All offic

es

Distrib

ution

ware

hous

es

Retail w

areho

uses

Shopp

ing ce

ntres

All reta

ils

Standa

rd re

tail

All pro

perty

Total return, average annual 2019-21Sources: MSCI, Gerald Eve

Forecasts by main property segment Sources: MSCI, Gerald Eve

www.geraldeve.com

Investment Brief

For more information on individual sectors, please see the following publications:

COMING SOON

Prime Logistics BulletinQ1 2019

Portfolio InvestmentSpring 2019

Multi-let2019

London MarketsWinter 2018/2019

Multi-letSummer 2018

Prime Logistics2019

Euro Cities2019

PRIME LOGISTICSThe definitive guide to the UK’s distribution property marketQ1 2019 Bulletin

PORTFOLIOINVESTMENTMARKETQ1 2019

International Property Consultantswww.geraldeve.com

LONDONMARKETS

International Property Consultants

Analysis of the London office market Winter 2018/2019

International Property Consultants

PRIME LOGISTICSThe definitive guide to the UK’s distribution property marketSpring 2019

EURO CITIES Analysis of the European property marketSpring 2019

International Property Consultants

South East Office BulletinQ1 2019

21 22

23 24 27

28

29

30

31

1

2

3

4

5

7 68

910

11

12

15

16

20

1918

17

14

13

2625

M23M3

M4

M40

M1 A1(M)

M20M2

M25

M11

Guildford

Croydon

Hemel Hempstead

Watford

Luton

Newbury

Reading Heathrow

Stansted

Gatwick

Oxford

High Wycombe

Royal Tunbridge Wells

Maidstone

Brighton

5.25% prime yields remained stable at 5.25% NIY

International Property Consultants

2019 SOUTH EAST OFFICES INVESTMENT BULLETIN FIRST QUARTER 2019

31deals completed throughout Q1 2019

2,000

2,500£ Million

1,500

1,000

500

0

Q1

2012

Q2

2012

Q1

2014

Q1

2016

Q3

2016

Q4

2016

Q1

2017

Q2

2017

Q2

2018

Q1

2018

Q4

2017

Q3

2014

Q2

2014

Q3

2015

Q4

2015

Q2

2015

Q4

2014

Q1

2015

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

Q4

2013

Q2

2016

Q3

2017

£114

6m

£713

m

£633

m

£155

2mFr

aser

s P

rope

rty

Por

tfolio

£632

m

£476

m

£876

m

£725

m

£718

mG

reen

Par

k

£327

m

£109

7m

£793

m

£1

16

6m

£924

m

£873

m

£111

7m

£559

m

£328

m

£103

7mC

hisw

ick

Par

k

£770

m

£480

m

£295

m£220

m

£452

m

£89m

£193

m

Q1

2019

Q4

2018

Q3

2018

£102

4m

£387

m

£880

m

Quarterly transaction volumes Q1 2012 - Q1 2019Source: Gerald Eve

Q1 2019 South East Office Investment Market Commentary Q1 2019 by numbers

32%of deals were completed by local authorities who were the most active buyers

UK Economic Overview

The UK economy is enduring a soft patch, reflecting the recent slowdown in world trade and ongoing Brexit-related uncertainty. But provided that Brexit is ‘orderly’, we expect strengthening household spending power and looser fiscal policy to underpin a modest acceleration in GDP growth through 2019 and into next year, with GDP growth forecast at 1.4% this year and 1.9% in 2020.

Undoubtedly Brexit uncertainty is continuing to be a key headwind to the UK economy as negotiations have remained at the forefront of the headlines. This has led investors to exert a higher level of caution on key decisions in the near term, until the UK’s relationship with the EU becomes clearer. However, if Brexit proceeds in an ‘orderly’ fashion we would expect the market to gather momentum in the second half of 2019.

South East Offices - Q1 Activity

Despite the challenging macro-economic and political environment, the resilience of the South East office investment market has been evidenced by a total transaction volume for Q1 2019 of £387 million. This is low in the context of the five year average (£575 million) but perhaps more than what would have been expected given the caution in the market. There were a total of 31 deals in Q1 2019, which reflects a significant amount of activity for lot sizes of sub-£20 million. Furthermore, there is over £400m avaliable on the market. Our analysis shows that the majority of deals were located in the Thames Valley and South of the M25, which is reflective of the liquidity and attractiveness of the core town centre locations such as Brighton, Reading and Windsor.

In Q1 2019 the prime and secondary yield gap widened further for South East offices, highlighting that investors are becoming increasingly polarised. Investors will typically target either prime core assets to capitalise on secure income, or, less frequently, value-add opportunities to drive capital and rental growth. Prime yields in Q1 2019 remained stable at 5.25%.

The South East occupational market remains resilient, with growth in headline and net effective rents evidenced across most South East markets in Q1. This was driven by buoyant occupational demand and lack of good quality grade A availability, which has been further exacerbated by residential permitted development, and, the scarcity of speculative office development.

Retail Fund Redemptions

Following substantial redemptions in December 2018 and January 2019 a number of retail funds’ cash positions were reduced to levels that triggered an element of forced selling. Whilst this was nationwide and across sectors, the window for purchasers to take advantage was limited and following selective disposals, normality has returned.

£387m of South East offices transacted

Local Authorities

Local authorities established themselves as the most active investor in 2018, accounting

for 28% of total acquisitions. They retained the largest share in Q1 2019, accounting for £115.3m and reflecting 32% of the deals completed. The majority of local authority transactions in Q1 2019 were completions on assets marketed in Q4 2018. Since January, we have seen demand from local authorities fall as most have now spent their annual budgets. We anticipate activity from local authorities to reduce further in Q2 2019 as purchasing activity is becoming more in borough focused and as the pre-election period approaches the local authorities enter purdah. We anticipate a bounce back in demand in the second half of 2019.

Institutions

Institutions remain active buyers for long income and prime assets in core town centre

and M25 locations. This was evidenced by Orchard Street’s acquisition of the Brinell Building, Brighton (4.74% NIY) and Schroder’s sale of Victory House, Brighton to NFU (exchanged at 4.83% NIY), both of which attracted competitive bids from several UK institutions. Refurbishment opportunities in core markets also remain in high demand as evidenced by FM Global’s sale of Windsor Dials which offered a unique 68,669 sq ft refurbishment opportunity in the heart of a sought-after market with a constrained supply pipeline. The limited availability of value-add opportunities meant that there was a very competitive bidding process with over eight bidders.

Property Companies

Whilst industrial rents and capital values are at record highs, the market has seen

property companies turn their focus to South East offices in search of yield arbitrage. Given that institutions remain focussed on a select number of core South East markets, property companies are taking advantage of attractive pricing for good quality offices in the more provincial South East locations. Furthermore, there continues to be depth to the lending market with competitive rates, which has favoured property companies and private equity investors. Notable deals by property companies include Dukesbridge, Reading which was acquired by Lipman Properties for £10.9 million.

Q1 2019 key investment transactions

Brinell Building, BrightonSize: 65,253 sq ftPrice: £39m (£600 psf)NIY: 4.75%Purchaser: Orchard Street

Theta Building, CamberelySize: 51,575 sq ftPrice: £13.4m (£260 psf)NIY: 7.80%Purchaser: Surrey Heath Council

CP House, EalingSize: 51,602 sq ftPrice: £23m (£446 psf)NIY: 3.93%Purchaser: Overseas

Ashbourne House, GuildfordSize: 35,557 sq ftPrice: £12.75m (£363 psf)NIY: 7.00%Purchaser: Rushmoor Borough Council

Victory House, BrightonSize: 84,988 sq ftPrice: £36.5m (£429 psf)NIY: 4.83%Purchaser: Exchanged

Florence Building, BasingstokeSize: 60,546 sq ftPrice: £29m (£472 psf)NIY: 4.00% Purchaser: LGIM

SOLD TO LETTO LET

1&2 Windsor Dials, WindsorSize: 68,669 sq ftPrice: *£25m (£364 psf)NIY: VPVendor: FM Global

UNDER OFFER

57%Institutions were the most active vendor, accounting for 57% of all transactions

£211mof South East offices are under offer across 18 deals and over £400m is on the market

The Heights, WeybridgeSize: 349,903 sq ftPrice: *£145m (£414 psf)NIY: 6.50%Vendor: M&G

Watson House, ReigateSize: 73,936 sq ftPrice: *£27.375m (£370 psf)NIY: 6.10%Vendor: M&G

ONES TO WATCH

ONES TO WATCH

*quoting prices

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15

Summer 2019

CONTACTS

John Rodgers PartnerTel. +44 (0)20 3486 3467Mobile +44 (0)7810 307422jrodgers@geraldeve.com

Lloyd Davies PartnerTel. +44 (0)20 7333 6242Mobile +44 (0)7767 311254ldavies@geraldeve.com

Leo Zielinski PartnerTel. +44 (0)20 3486 3468 Mobile +44 (0)7980 809031lzielinski@geraldeve.com

Nick Ogden PartnerTel. +44 (0)20 3486 3469Mobile +44 (0)7825 106681nogden@geraldeve.com

UK Capital Markets

Portfolios

London offices Industrial & Logistics

Research

Ben Clarke Senior AssociateTel. +44 (0)20 7333 6288bclarke@geraldeve.com

Research

Alex Dunn AssociateTel. +44 (0)20 3486 3495Mobile +44 (0)7917 587230adunn@geraldeve.com

South East Offices

Guy Freeman PartnerTel. +44 (0)20 3486 3471Mobile +44 (0)7796 813141gfreeman@geraldeve.com

Regional Investment Healthcare

Alternatives/Long income

Leisure Leisure Valuations

Richard Moir PartnerTel. +44 (0)20 7333 6281Mobile +44 (0)7771 812249rmoir@geraldeve.com

Will Kirkpatrick PartnerTel. +44 (0)20 7333 6228Mobile +44 (0)7836 287983wkirkpatrick@geraldeve.com

Richard Lines PartnerTel. +44 (0)20 7333 6274Mobile +44 (0)7825 721289rlines@geraldeve.com

Daniel Anning PartnerTel. +44 (0)20 7333 6374Mobile +44 (0)7776 161821danning@geraldeve.com

Charles Wilford PartnerTel. +44 (0)20 7333 6215Mobile +44 (0)7774 834113cwilford@geraldeve.com

Michael Riordan PartnerTel. +44 (0)20 7653 6828Mobile +44 (0)7796 611127mriordan@geraldeve.com

Callum Robertson PartnerTel. +44 (0)16 1259 0480Mobile +44 (0)7810 655791crobertson@geraldeve.com

Hotels

Research

Steve Sharman PartnerTel. +44 (0)20 7333 6271Mobile +44 (0)7508 008118ssharman@geraldeve.com

Research

Sophie Jones Research AnalystTel. +44 (0)203 486 3784sjones@geraldeve.com

London (West End) 72 Welbeck Street London W1G 0AY Tel. +44 (0)20 7493 3338

London (City)46 Bow Lane London EC4M 9DL Tel. +44 (0)20 7489 8900

BirminghamBank House, 8 Cherry Street Birmingham B2 5AL Tel. +44 (0)121 616 4800

Cardiff32 Windsor Place Cardiff CF10 3BZ Tel. +44 (0)29 2038 8044

Glasgow140 West George Street Glasgow G2 2HG Tel. +44 (0)141 221 6397

Leeds1 York Place Leeds LS1 2DR Tel. +44 (0)113 204 8419

ManchesterNo1 Marsden Street Manchester M2 1HW Tel. +44 (0)161 259 0450

Milton KeynesAvebury House 201-249 Avebury Boulevard Milton Keynes MK9 1AU Tel. +44 (0)1908 685950

West Malling35 Kings Hill Avenue West Malling Kent ME19 4DN Tel. +44 (0)1732 229420

Disclaimer & copyrightThis brochure is a short summary andis not intended to be definitive advice.No responsibility can be accepted forloss or damage caused by reliance on it.

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The reproduction of the whole or partof this publication is strictly prohibitedwithout permission from Gerald Eve LLP

06/19