property iq - deloitte united states · uk commercial property overseas investment drives activity...

Real Estate

Deloitte Insight

Q4 2014

After a sterling year, what next?

Property IQ

AuthorsJames GriggsInformation Unit [email protected]+44 (0)20 7303 3158

Will MatthewsReal Estate [email protected]+44 (0)20 7303 4776

2014 was an outstanding year for UK commercial property. The latest monthly IPD figures show annual total returns have climbed to 20%, a level not seen over the last 20 years. To date, around £46 billion has been invested in the market this year, one of the highest totals ever.

It will be tough for 2015 to match this performance. The consensus view is that returns will roughly halve to a respectable but much less exciting 10% or so. But is this being too pessimistic?

Yields have fallen further and faster than was generally expected during 2014 – limiting the scope for further falls and therefore also limiting capital growth induced by yield compression. Indeed the IPD All Property equivalent yield fell 86bps over the year to October, compared with just 5bps over the previous twelve months. But below the headline figures there are plenty of subsectors where yields are nowhere near the bottom of their historic ranges and could therefore offer further yield-driven capital growth. These include regional office property, shopping centres and retail warehouses.

Source: Deloitte Real Estate

Sector Category Jun

‑09

Jul‑

09

Au

g‑0

9Se

p‑0

9O

ct‑0

9N

ov‑

09

Dec

‑09

Jan

‑10

Feb

‑10

Mar

‑10

Ap

r‑10

May

‑10

Jun

‑10

Jul‑

10A

ug

‑10

Sep

‑10

Oct

‑10

No

v‑10

Dec

‑10

Jan

‑11

Feb

‑11

Mar

‑11

Ap

r‑11

May

‑11

Jun

‑11

Jul‑

11A

ug

‑11

Sep

‑11

Oct

‑11

No

v‑11

Dec

‑11

Jan

‑12

Feb

‑12

Mar

‑12

Ap

r‑12

May

‑12

Jun

‑12

Jul‑

12A

ug

‑12

Sep

‑12

Oct

‑12

No

v‑12

Dec

‑12

Jan

‑13

Feb

‑13

Mar

‑13

Ap

r‑13

May

‑13

Jun

‑13

Jul‑

13A

ug

‑13

Sep

‑13

Oct

‑13

No

v‑13

Dec

‑13

Jan

‑14

Feb

‑14

Mar

‑14

Ap

ri‑1

4M

ay‑1

4Ju

n‑1

4Ju

l‑14

Au

g‑1

4Se

p‑1

4O

ct‑1

4Shops

Prime major cities

Cathedral cities

Market towns

Shopping centres

Regional dominant

Sub‑regional

Major town centre schemes

Smaller urban schemes

Retail warehouses

Parks (open A1)

Parks (bulky)

Solus

Car showrooms

Let to dealership

Let to manufacturer

Leisure parks

Supermarkets Standalone superstore

Industrial

Distribution (15 year term)

Distribution (5 year term)

Modern ind. est. (Regional)

Modern ind. est. (South East)

Offices

City

West End

Midtown

West London

South East

Major cities

Out‑of‑town

Deloitte Real Estate Yield Matrix – changing sentiment towards yields on prime propertyOccupier weakness has caused sentiment to fall in the supermarkets subsector

Sentiment indicator: n Sentiment weakening n No change in sentiment n Sentiment strengthening

Yields in some parts of the market have fallen to very low levels – most notably the central London office submarkets – and the potential for further falls would appear to be limited, among other things, by the risk-free rate. However with the five-year swap rate now down to around 1.5% as expectations for a rise in base rates get pushed back into the second half of 2015, this margin remains attractive even as property yields compress. It is also worth remembering that the impact of yield compression on capital values is not linear: a 25bps fall in yield has over twice the impact on values when yields are 3.5% as when they are at 7%.

And there are other reasons why yields could fall further. Overseas investors were responsible for over 40% of deals this year by value, a share that has been steadily growing from around 20% at the start of the century. Looking to 2015, foreign investment could see another strong year as concerns over emerging market growth prospects promote the ‘safe haven’ trade, and the pool of countries and their institutions targeting overseas capital deployment continues to grow.

On the other hand, there will be more political factors in play, not least the May general election and the prospect of an EU referendum, which could slow investment activity.

Yet there is little doubt that performance will be more reliant on rental growth over the next phase of the cycle. In many sectors this has been slow to recover, but is now taking hold, particularly in prime parts of the market where delivery of new stock has been limited since the downturn.

Indeed construction output growth for commercial and industrial new work has slowed since the early summer – growing by just 1% over the year to September – and the key central London office market looks set to deliver one of the lowest quantities of new space in 2015 in 20 years. With demand for grade A space in London expected to outstrip supply for three more years, headline rents are also forecast to rise over the same period.

And of course rental growth in the wider regional market will be supported by the next phase of the economic recovery, which should see a confirmation of corporate expansion and a shift towards stronger consumer spending as wages finally start to show meaningful growth in real terms.

Rental growth is rarely as strong a driver of performance as the impact of yield compression, and some of it may have already been accounted for in current pricing, so there is a risk of double-counting the benefit of rental growth as it starts to come through more strongly. Initial yields may have fallen to around 6%, but with some further yield-driven capital growth to come, and a period of more widespread rental growth ahead, there are clear reasons to expect higher returns than the current consensus suggests.

0%

10%

20%

30%

40%

50%

60%

70%

2014

.Q1

2013

.Q1

2012

.Q1

2011

.Q1

2010

.Q1

2009

.Q1

2008

.Q1

2007

.Q1

2006

.Q1

2005

.Q1

2004

.Q1

2003

.Q1

2002

.Q1

2001

.Q1

2000

.Q1

Overseas investors’ share of market

Source: Property Data

-10

0

10

20

30

Q3-14Q2-14Q1-14Q4-13Q3-13Q2-13Q1-13

12-month total returns: by asset class (%)

Source: IPD/MSCI

Direct property Property equities

Equities – all share Gilts 5 to 10 yrs

Property IQ After a sterling year, what next?2 |

The economy

A year of solid growth expectedEconomy continues to show solid growth

• Despite the rate of GDP growth easing from 0.9% to 0.7% in Q3, the outlook remains robust. Business activity surveys point to a similar rate continuing through Q4 and the consensus view expects growth next year to settle back to a still-strong 2.6%.

• Continued weakness in the Euro area remains one of the chief risks to growth, which along with the strength of sterling is making life hard for exporters.

Corporate confidence still high

• Large corporates’ appetite for taking further risk onto their balance sheets has reached a seven-year high, according to the Q3 Deloitte CFO survey.

• However, elsewhere the survey also shows signs of a more cautionary approach among respondents, with defensive overtaking expansionary strategies. Concerns over the strength of emerging economies has risen, alongside those over the Euro area.

North West due to perform well in 2015

• All regions are forecast to show healthy economic growth in 2015. London still heads the table, by a margin, but further down the order has a slightly different feel. The North West sits above the South East in the ranking, benefitting from increased business activity in areas such as engineering, wholesale trade and hospitality. This is reflected in the results of Deloitte’s recent Businesses leading Britain report, which identifies the East Midlands and the North West as hotspots of growth among medium-sized companies.

• But over the longer term, demographic and sector employment trends will continue to favour London and the South East.

0.0

1.0

2.0

3.0

4.0

20152014

Changing consensus forecasts for GDP growth

Jun-14 Jul-14 Aug-14 Sep-14 Oct-14

Aug-13 Sep-13 Oct-13 Nov-13Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14Jun-13

Forecasts made in:

Jul-13

Source: HM Treasury

GD

P gr

owth

%

0%10%20%30%40%50%60%70%80%

Risk appetite% of CFOs who think this is a good time to take greater risk onto their balance sheets

Source: Deloitte CFO Survey

Sep-

07

Mar

-08

Sep-

08

Mar

-09

Sep-

09

Mar

-10

Sep-

10

Mar

-11

Sep-

11

Mar

-12

Sep-

12

Mar

-13

Sep-

13

Mar

-14

Sep-

14

GVA growth 2015 forecast %

Source: Oxford Economics

0% 1% 2% 3% 4% 5%

North East

N Ireland

Yorks & Humber

Scotland

West Midlands

East Midlands

Wales

South West

South East

North West

Eastern

Greater London

| 3Property IQ After a sterling year, what next?

UK commercial property

Overseas investment drives activity2014 investment should be close to record

• With over £16 billion of investment deals completed during Q3, 2014’s total was almost 20% ahead of 2013 at the same point, and given the traditional volume of activity at the year end, appears on course to match the peak volume of 2006.

Overseas investors dominant …

• Foreign investors saw a significant increase in their share of the market over Q3, from 36% to 46% of all deals by value. This was largely at the expense of UK property companies, whose share fell from 25% to 18%, reflecting a greater degree of selling.

• The strength of the UK economy – in particular relative to other countries – has been one factor in its attractiveness to overseas money.

• The third quarter saw a range of deals completed over £200 million, including regional portfolios and retail assets, as well as central London shops and offices, with a range of investor types involved.

… but little evidence of moving from London

• Over three quarters of overseas cash spent on UK commercial property is spent in London, with the West End and City submarkets taking an almost identical share. Despite evidence of an increased share of spending outside London and the South East by overseas investors in 2014 (mainly down to the major retail asset deals) to 17%, up from 10% in 2013, this only brought it back in line with the levels in 2011 and 2012.

0

20,000

40,000

60,000

80,000

Property investment by quarter (£ million)

Q3 Q4Q1 Q2


1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Share of investment by investor type Q3 2014


2%2%

46%

5%

27%

18%

Owner occupiers

Overseas investors

Private investors

UK institutions

UK property companies

Others

0%

20%

40%

60%

80%

100%

20142013201220112010

Overseas investment by region

Rest of London London West End London – City

South East Rest of UK




Further growth to come in the regionsAlternative assets prove attractive

• Non-core assets have been strongly targeted by investors this year. Prospects for the hotel sub-sector are positive: a restrained level of new supply, combined with improving operating fundamentals this year and the forecast of increasing economic activity around the regions.

• Prime leisure parks have seen yields fall 75bps over the last twelve months, with purchasers attracted by the stable income stream provided by relatively long leases.

Regional assets see strongest yield compression

• Over the year to date, the strongest falls in prime yields have generally been seen in the regional markets. In particular, shopping centres have attracted significant investor interest, with demand filtering down from the largest schemes to smaller assets. Retail parks have also benefitted from this sentiment.

• In the office sector, London Midtown, for a long time showing the largest falls, has been overtaken by business parks and prime offices in the major regional cities.

Rental picture still patchy

• As yield compression slows, investors will look to rental growth to support returns. But office rental growth to date remains sharply divided between London and the rest of the country. According to IPD’s Q3 figures while West End and Midtown offices are recording annual growth of over 10%, and outer London achieving 7%, the average across the rest of the country is just 1.4%, with the South East and Wales the best at just over 3%. The range of rental performances has widened since Q1, suggesting the regional catch-up has yet to get into full swing. Indeed some regions are still seeing office rents decline.

• Comparing Q3 with Q1, the fastest pick-up outside London was in Wales, Yorkshire & Humber, and the Eastern region.

North West

East Midlands

Scotland, 0.7

North East, ‑0.8

Yorkshire & Humber, 1.8

East Midlands, ‑0.7

West Midlands, 1.3

Wales, 3.2

North West, 1.2

East, 3.1

South East, 3.3

South West, 0.6

Source: IPD/MSCI

Office annual rental value growth, Q3 2014 (%)

Fall in yields year to date, percentage points (selected sectors)

Source: Deloitte Real Estate

0.00% 0.25% 0.50% 0.75% 1.00%

Offices – CityShops – major cities

SupermarketsCar showrooms (dealerships)

Leisure parksShops – market town

Prime distribution 15-yr termOffices – West London

Offices – MidtownOffices – South East

Retail parksShopping ctrs – regional dominantShopping ctrs – major town centre

Offices – out-of-townOffices – major cities

Modern ind estate – regional

Alternative sector investment volume by quarter, £ millions

Leisure Other


Dec

-08

Mar

-09

Jun-

09Se

p-09

Dec

-09

Mar

-10

Jun-

10Se

p-10

Dec

-10

Mar

-11

Jun-

11Se

p-11

Dec

-11

Mar

-12

Jun-

12Se

p-12

Dec

-12

Mar

-13

Jun-

13Se

p-13

Dec

-13

Mar

-14

Jun-

14Se

p-14

0

1,000

2,000

3,000

4,000

5,000

6,000

Outer London, 7.0

City, 8.6

Midtown, 11.7

West End, 10.2



Positive outlook across the sectorsFor retail, consumer confidence is up, though caution remains

• Consumer confidence continues to pick up, as wage growth finally gathers pace and employment numbers improve. However the overall response is still one of caution, with sentiment about levels of debt and disposable income, as measured by the Deloitte Consumer Tracker, still negative.

• Retail warehouses have performed strongly this year, achieving the best annual capital growth at the Q3 point among the main retail sub-sectors, driven by one of the sharpest yields compressions since the start of the year.

• As our Yield Matrix table at the front shows, sentiment in the supermarket subsector has weakened in the light of concerns over margin levels and rental growth prospects.

Industrial favoured over medium term

• With its stronger income component, industrial property is expected now to produce the highest returns over the 5-year forecast horizon, an annualised 10.5% compared with All Property’s 9.2%.

• The consensus view published by the IPF sees All Property total returns falling back to just below 11% in 2015 and below 7% in 2016, as the effect of yield compression gives way to rental growth as the main driver.

Office sector supported by employment growth

• Service sector business activity measures indicate that output in office-type activities is set to grow, and together with rising regional employment levels in this sector, this supports a positive outlook for office rental growth.

• Outside London, construction of new office space is expected to pick up during 2015. Developer confidence in the regions is re-emerging, and speculative office schemes are back on the agenda as levels of available space continue to fall. Manchester, for example, has seen 325,000 sq ft of new office space start in 2014, with a further 1.5 million sq ft in the pipeline.

-50%

-40%

-30%

-20%

-10%

0%

Sep-

14

Jun-

14

Mar

-14

Dec

-13

Sep-

13

Jun-

13

Mar

-13

Dec

-12

Sep-

12

Jun-

12

Mar

-12

Dec

-11

Sep-

11

UK consumer sentiment about personal situation

Source: Deloitte CFO Survey Q3 2014

Household disposable income Level of debt

48

53

58

63

Oct

-14

Jul-1

4

Apr

-14

Jan-

14

Oct

-13

Jul-1

3

Apr

-13

Jan-

13

Oct

-12

Jul-1

2

Apr

-12

Jan-

12

Oct

-11

Jul-1

1

Apr

-11

Jan-

11

Oct

-10

Jul-1

0

Apr

-10

Jan-

10

Service sector: balance of business activity

Source: Markit/CIPS

Service sector activity 50 = no change on previous month

-30

-20

-10

0

10

20

30

All Property total return outlookAnnual total returns %

RangeIPD historic IPF consensus central forecast

Source: IPF Consensus Forecast Report November 2014

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016


Recent publications

UK Futures:Businesses Leading Britain 2014:

A new lens on growth

London Office Crane Survey Winter 2014: Building

momentumThe State of the State 2014‑15: Government’s inflection point

London Futures: Agiletown – the relentless march of technology and London’s

response

Deloitte CFO Survey Q3 2014 London Industrial: Taking stock of the capital

Deloitte Consumer Tracker Q3 2014

Shed of the Future: E‑commerce

– its impact on warehouses

Recent research

London Business Footprint Mapping change in the office marketDeloitte Real Estate has undertaken a comprehensive study of

office occupation in central London over the ten year period 2004

to 2014. Creating a database of over 18,000 records of businesses

and the office space they utilise, has enabled us to show how the

market has changed, at both a macro and micro level.

Even amongst the broadest categories of businesses, there have

been some notable migration patterns across London’s main

office markets. This report demonstrates the fluidity of the central

London office market and outlines what some of the drivers of

future change will be.

Shaun DawsonResearch+44 (0) 20 7303 [email protected]


Key contacts

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Deloitte LLP is the United Kingdom member firm of DTTL.

This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out will depend upon the particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication. Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.

© 2014 Deloitte LLP. All rights reserved.

Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered office at 2 New Street Square, London EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000 Fax: +44 (0) 20 7583 1198.

Designed and produced by The Creative Studio at Deloitte, London. 40568A

Anthony DugganHead of Real Estate [email protected]+44 (0)20 7303 3134

Julian StocksHead of UK [email protected]+44 (0)20 7303 7210

Philip ParnellHead of Management and [email protected]+44 (0)20 7303 3898

8 | Property IQ After a sterling year, what next?

property iq - deloitte united states · uk commercial property overseas investment drives activity...

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