The UK property market has enjoyed a period of relative stability since the last recession, but wise investors always keep one eye on wider economic indicators that could affect values and income
As we enter the final quarter of 2017, the market is more volatile and unpredictable than ever. Auctions are the bellwether of the market, but what other signals should you track to give you confidence for the period ahead? EG looks at the most important leading indicators for the residential and commercial property market and what direction they are pointing in.
Business investment
Business investment is the most fundamental representation of the potential growth of occupiers. It also feeds through into the wider consumer economy – how much money employees have in their pockets to spend on housing, retail and leisure.
According to the latest UK Business Confidence Monitor from the Institute of Chartered Accountants in England and Wales, confidence plummeted at the beginning of the third quarter of the year, scored at -8, having turned positive in the previous quarter (6.7) for the first time since the EU referendum. Some 27% of businesses felt more confident than in the previous quarter, but 39% felt less confident.
Matthew Weiner, chief executive of developer U+I, says: “Half the problem currently is that the data is all over the place and, while it has not fed through yet, if there is continuing uncertainty, business may stop investing. The problem is that if we start building, we can’t stop.”
Base rate and bond yields
Short-term interest rates govern economic expansion, which feeds through into space demand and rental growth which, over the long term, is the main driver of commercial property returns.
Most importantly, the differential between interest rates and bonds and their differential with prime property yields reflects the sector’s attractiveness. Cheap borrowing also helps pump up pricing and potentially distressed borrowers can more easily service their debt.
The Bank of England slashed interest rates to 0.25% in the wake of the Brexit vote last August, having been set at 0.5% at the height of the financial crisis in 2009. This has given the property industry a relative tailwind, but with inflation at 2.9% – 90bps above the target – and the Fed edging up rates in the US, a rise is expected in the near future and the property industry could start to feel the sting.
Last month, Bank of England governor Mark Carney said “some withdrawal of monetary stimulus is likely to be appropriate over the coming months” to help return inflation to its 2% target.
Mike Prew, managing director and analyst at Jefferies, predicts that it will only be “alternative” property sectors that show structural demand (for example, logistics, warehousing, student accommodation, low-cost housing and self-storage) that can expect to be sheltered from any correction.
Listed companies’ premiums and discounts
If investors are convinced the industry is peaking and a fall is fast approaching, companies’ share prices will fall below their net asset value. It means the market is forecasting a fall that is not yet reflected in the company’s book value of its properties.
Jefferies recently estimated that British Land and Landsec are trading at a 31% and 28% discount to spot NAV. Shopping centre REITs are also exposed to investor pessimism, led by discounts of 38% at intu and 23% at Hammerson, while Derwent London and Great Portland Estates’ double-digit discounts reflect downsides in the London office market.
But that is not a trend in all UK property. Investors are expecting growth in the self-storage and industrial sectors, with Big Yellow Group, Safestore, LondonMetric and SEGRO all trading at a premium to their NAV.
Rental growth versus yields
When the cycle is in full swing you can expect property values to rise, yields to fall and rents to grow. But when rents start falling while prices continue to rise, something is going wrong. Values stop reflecting underlying returns, eventually growing at an unsustainable rate.
The London market is inundated with news of record-breaking deals, led by the £1.3bn sale of 20 Fenchurch Street, EC3, in July with a yield of 3.4%. Capital value growth in central London offices was 2.5% in the first half of the year, while rental growth stagnated at 0%, according to CBRE.
Meanwhile, Carter Jonas predicts an 8% fall in headline rents across London in the next two years. It is only a matter of time before investors will stop seeing the value in paying higher and higher prices for lower income.
Recruitment
Unemployment is currently at a 42-year low in the UK, at 4.4%. To some extent this reflects the buoyancy of the economy, although it can also reflect a skills shortage. Activity of recruitment firms can, however, give a more definitive view on future intentions and a clearer leading indicator.
According to recruitment firm Adzuna, there were 1,231,552 vacancies in August – a 6.6% annual increase. “Opportunities for jobseekers and employees are rife at present – despite Brexit plans on the horizon – with more roles being created and the jobs market continuing to prove itself resilient,” it reports.
Housebuilding
Britain’s housing crisis is rarely out of the headlines. So the response from our biggest private housebuilders is worth keeping an eye on.
Housing starts and completions have increased from the lows of late 2008 and early 2009 but remain below pre-recession levels.
There were 41,180 house building starts (seasonally adjusted) in England in Q2 2017, a 3% decrease on the previous quarter, but up 10% on the same quarter of 2016. This is above the recent low of 17,150 in Q1 2009, but still below the 48,970 starts in Q1 2007.
House prices
The autumn traditionally sees house prices pick up after a summer lull, but UK house prices grew at the slowest annual pace in more than five years in August as a slump in London weighed on the market.
Asking prices rose by 1.1% from a year earlier, according to Rightmove, down from 3.1% in August. September had the first month-on-month decline in four years as values in London slumped.
The slower price growth is attracting more buyers, with the number of sales agreed up by 4.8% from a year earlier.
“Having finally turned the tables to potentially improve their buying power, buyers will now be hoping that it is not eroded again by an interest rate rise or rampant consumer-price inflation,” says Miles Shipside, a Rightmove director and housing market analyst.
Mortgages
Bank of England data on the number of mortgages approved to finance house purchases are a leading indicator of house sales.
Approvals remain well down on pre-recession levels. However, mortgage approvals in July 2017 were up by 5.2% on the previous month and up by 11.3% on a year ago. There were 68,689 mortgage approvals in July 2017, compared with 61,733 in July 2016.
Residential rental demand
Soaring house prices and stagnant wages mean home ownership is out of reach for growing numbers of people.
Around 5m households in Britain, or 21% of the total, are currently in private rented accommodation, a quarter of which are families with children. What is important to know is that this is set to rise to 5.79m (or 24%) over the next five years, alongside 14.3m owner-occupiers and 4.3m social tenants. The figures come from the latest annual report on the market by Knight Frank, which commissioned a YouGov survey of more than 10,000 tenants and spoke to 26 major investors.
The Knight Frank report says that while at least three-quarters of UK renters are living in homes owned by private landlords, they will increasingly rent from large-scale corporate landlords, such as City firms and property companies.
So what about rents? Given the current supply/demand mismatch, respondents to the latest RICS residential market survey continue to anticipate further rental growth over the coming 12 months. Indeed, over the next five years, contributors expect rental growth to outpace that of house prices, averaging 3%, per annum (against 2% house price inflation). However, 61% of respondents expect more landlords to exit (rather than enter) the market in the next 12 months due to recent policy changes.
To read about how you could grow your wealth through auctions, why not register for immediate access to EG’s Property Auction Buyers’ Guide.
