Expectations of UK commercial property at the beginning of 2017 were that it would be challenging for values, yields and take-up due to uncertainty and confusion caused by the negative impact of Brexit.
However, investment in the first three quarters of 2017 was up 33% on the same period in 2016, with volumes of £18bn in Q3 up 23% from Q2 and more than double the amount invested in Q3 2016. Fuelled by 32 deals over £100m, this was the strongest third quarter since the financial crisis, followed by a profusion of major regional deals in the final quarter of the year. This is expected to continue during 2018 and into the future.
Of particular note is the performance of the sectors below:
Industrial & logistics
The outlook for investment remains very positive due to the non-cyclical characteristics and ongoing stability of the industrial sector, coupled with the ever-rising requirement for more units for warehousing due to the UK’s insatiable appetite for online shopping and increasing demand for last mile click and collect.
The remarkable performance of the sector in 2017 delivered rental growth of circa 5%, against a median expectation of 0.9%, which has led to substantial yields as industrial units are in high demand and short supply. Continued pressure on land, particularly inside London, from other uses will maintain undersupply which will continue to deliver extra rental growth and a higher income yield. This contributed to the 12.5% capital growth in 2017 which saw asking prices for industrial estates regularly exceeding 100 bps, and transactions in and around London and the South East completing with yields that start with a 3.
USB’s Gauge expects returns in this sector to continue to lead the market for at least the next three years, and Savills expect ‘urban logistics’ to generate the highest average annualised returns between 2018 and 2022 as the sector looks set to deliver “both the highest income yield and strongest capital growth prospects”.
Ongoing changes in work patterns continue to fuel demand for flexible office space. The take-up of offices in central London, particularly in the city, was strong in 2017 and it’s predicted to reach 6.25m sq ft which is well above the 10-year average of 5.4m sq ft, despite concerns about Brexit and low rental value growth in London.
JLL’s report shows that prime headline rents across the UK’s top six regional cities have increased on average by 5% over the last two years and it forecasts an average increase of 2.2% over the next four years and expects they will continue to offer extra yields.
Ben Burston, head of UK Offices Research at JLL, suggests that limited speculative office development is driving rental growth as only 693,000 sq ft of offices is due to complete in 2018 with a further 933,000 sq ft anticipated in 2019. This falls well short of the level of demand for new office space. Again this is caused by competition from other uses of space and rising construction costs across the UK regions, on top of the high cost and limited availability of debt.
“The regional office market is still adjusting to the seismic change in credit markets post financial crisis and the resulting lack of development supports rental growth and is encouraging occupiers to take pre-lets.”
Flexible office providers have taken advantage of this situation, and there has been an explosion with the sector accounting for 1.2m sq ft of take-up, which has contributed to the high levels. During 2018 the proportion of the market seeking flexible space is expected to increase.
Investment from overseas
There has been a huge amount of foreign capital flowing into the UK commercial property market, up 25% compared to 2016, predominantly from the Far East and the US. This is due to the value of sterling, continued low interest rates and low returns on fixed income and cost of debt, and the fact that they are looking at a longer-term horizon and income security. They are not swayed by uncertainty about Brexit as the countries the investors come from have political situations that make Brexit look like a storm in a tea cup. The majority of foreign investment in 2017 was directed towards London, with £12bn allocated to London offices.