The performance of the UK economy continues to be underwhelming. UK economic output has been disappointing since the GFC and expectations of the outlook for the next two years are lower still.
Market interest rate expectations are indicative of a 25 bps cut in Bank Rate in Q1 2020 back to 0.5% where it remains until the end of the forecast period. Jon Cunliffe, Deputy Governor of the BoE has recently warned that the current “lower for longer” environment risks more severe economic downturns.
Gilt yields have hardened by a further 37 bps since the end of Q2. The pricing of UK real estate continues to be attractive relative to other asset classes.
Risk and uncertainty are heightened currently and key metrics are indicative of a coming recession.
MSCI data indicates that All Property values contracted in Q3 for the fourth consecutive quarter. the market is differentiated by poorly performing retail assets, stagnant offices and the continued out-performance of industrials. All Property capital values decreased by a further -0.7% as retail capital values fell by-3.1%. But, office capital values rose by 0.2%and industrial values increased by 0.6%.
Office and industrial rental value growth remains positive. South East industrial rental value growth is still strong by historical standards and growth in West End rental values has strengthened.
However, rental values for shopping centres, retail warehouses and shops continue to fall.
August’s IPF Consensus Forecast round continues to indicate that 2019 is expected to represent a cyclical trough.
All Property performance expectations for 2019 weakened from 1.8% to 0.9% and expectations for 2020 were reduced to 2.9%from 3.1% in May. Capital values are now expected to shrink by 4% in 2019 and 2% in 2020.
In the medium to long term we continue to expect a slowing global economy and the UK’s exit from the EU to entrench the current slow-down in domestic economic growth. This will restrain rental growth and cause yields to soften further. Consequently, we expect a gradual weakening in property values over the next three years. As the outlook has weakened this quarter and the risks appear to strengthening, our three year forecast has decreased from an average annualised total return of 4% to 3%.