Market indicators: where is the industry headed?

31st August 2017

With the market more volatile and unpredictable than ever, what can you rely on to give you confidence for the period ahead? With the masses returning to work from their summer breaks, EG looks at the most important leading indicators for the 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.

What is the current situation?

According to the ICAEW’s latest UK Business Confidence Monitor, confidence plummeted at the beginning of the third quarter of the year, scored at -8, having turned positive the previous quarter (6.7) for the first time since the EU referendum. Some 27% felt more confident than the previous quarter in Q3 but 39% felt less confident.Matthew Weiner, U+I chief executive says: “Half the problem currently is that the data is all over the place and,  while it hasn’t 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.

 What is the current situation?

The Bank of England slashed interest rates to 0.25% in the wake of Brexit 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% – 90 bps above the target – and the Fed edging up rates on the other side of the pond, a rise is expected in the near future and the property industry could start to feel the sting.Mike Prew, managing director and analyst at Jefferies, predicts that it will only be “alternative” property sectors that show any 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.

What is the current situation?

Jefferies estimated this week 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 vs 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.

What is the current situation?

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 research predicted 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.

The auction room

Auctions give us an immediate snapshot of market confidence at any given time. Auction investors in commercial property are overwhelmingly cash buyers – Allsop’s commercial auctions have 80% cash buyers – meaning they could just as easily not buy any property, or put the money into bonds. If they are scared, they will leave their money in the bank.

What is the current situation?

In spite of three well-documented shocks – Brexit, Trump and the general election – success rates are holding strong, according to George Walker, partner in charge of commercial auctions at Allsop.Walker says Allsop’s auction success rate dropped during May, but is now holding steady at around 87%. For context, in 2007, that figure was 76%, as investors’ dwindling faith in the market failed to achieve the reserves on offer. This year, overall transaction volumes are up on 2016.

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.

What is the current situation?

According to recruitment firm Adzuna, the number of advertised vacancies in the UK jobs market hit a 19-month high in June, with 1.2m jobs posted – a 3.9% increase on the previous year. In line with this, the number of jobseekers per vacancy dropped by 18%.This is also being borne out in the property industry. Peter Moore, managing director of property recruitment firm Macdonald & Company, says he expects the influx of capital from investors without established platforms to boost business.“A number of these investors are developers who are looking to build teams on the back of their purchases. They compete for talent against existing UK operators and ultimately hire experienced UK staff. The UK companies then have to replace those people so there is a lot of churn,” he says.