WHAT NEXT FOR MORTGAGE RATES?
UK inflation may have already peaked after falling from a 41-year high of 11.1 per cent to 10.7 per cent in November, but there are concerns that price rises could prove stickier than elsewhere in the world. Inflation has been slowing globally towards the end of 2022, as energy and commodity prices have begun to fall, and long-standing supply chain woes have started to dissipate. The bigger-than-expected fall in UK inflation prompted the Bank of England to opt for a smaller 50 basis point interest rate hike to 3.5 per cent in its eighth consecutive rise this year.
But the BoE's Monetary Policy Committee (MPC) highlighted uncertainties in the outlook for UK inflation, and therefore the outlook for the bank's hiking cycle, as Britain grapples with the impact of a tight labour market and rising wages. The MPC's policy apprehension was demonstrated by its division, as three of the nine-person group voted against a 50bps hike, with one voting for a 75bps rise and two voting for a pause.
The MPC report said that while inflation is expected to 'continue to fall gradually over the first quarter' of next year, there remain 'considerable uncertainties around the outlook'. It explained that the expectation of a continued gradual fall is driven by the assumption that earlier increases in energy and other goods prices drop out of the annual comparison. However, the MPC said, 'further shocks to energy and other commodity prices [continue] to present some upside risks to the central outlook', while Britain's labour market presents its own idiosyncratic cost pressures.
The MPC said: 'The labour market remains tight and there has been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence.' Unemployment has remained surprisingly low given Britain's worsening economic outlook, albeit alongside surging levels of 'economic inactivity', while wages are also on the rise and adding to inflation concerns.
In a letter to Chancellor Jeremy Hunt, published alongside the MPC minutes, governor of the BoE Andrew Bailey said: 'As firms have passed on rising labour and other costs to consumers, inflationary pressures have broadened to sectors in which price setting is driven more by domestic costs than traded goods prices. 'Consumer services inflation, for example, remained high at 6.3 per cent in the November data.' While the BoE is expecting a 'gradual' CPI decline, head of market analysis at Brewin Dolphin Janet Mui said inflation was likely to slow 'sharply' in 2023.
Commodity prices, including wholesale oil and gas, have fallen notably. Inventories of goods are building up and shipping costs are falling rapidly, which are good signs for price pressures to fall.
According to the latest figures compiled by HM Treasury, City forecasts predict average consumer price inflation to fall from a fourth-quarter reading of 10.5 per cent to 5 per cent for 2023. For its part, the BoE has said it expects inflation to remain over 10 per cent 'in the near term', before falling 'some way below' its 2 per cent target by 2024.
NEW YEAR, NEW HOME, NEW HOPE: RESIDENTIAL
Number of people putting their house up for sale jumped 46% over the late Christmas period according to Rightmove.
The number of people putting their homes up for sale on Boxing Day soared by 46 per cent compared to the year before, data from Rightmove has revealed. There was also a surge in activity from prospective sellers requesting home valuations, the property website said.
The week after Christmas Day, from 26 December onwards, was the busiest week for valuation requests since early September, as they were up 29 per cent compared to the same time in 2021.
Furthermore, the number of views of homes for sale on Rightmove jumped by 20 per cent between the week of Christmas and Boxing Day week, as prospective buyers started to plan their next moves.
The activity may signal the end of the Christmas slump in property activity which many reported starting earlier last year than usual, owing to the uncertain economic conditions. Rightmove has seen some promising activity and familiar patterns over the festive period, which are good signs for the year ahead.
While we expect a calmer market this year than we've had since the pandemic started, the record number of sellers who chose to come to market this Boxing Day indicates there is a group of motivated sellers ready to move.
After such frenetic market conditions over the last few years, this year's calmer market will better suit measured movers who prefer to take their time to find the right property. After a pause for the festivities, those wanting to buy this year will be ready to get back to their plans and assess where they'd like to live and what they can afford. Those sellers who got a head start and have their home already up for sale will now be benefitting from the jump in viewings over the next few weeks, as people settle back into their usual routines. However, the market is sensitive to price so those vendors unwilling to adjust the sales price will languish while others being proactive and pragmatic about pricing will sell ad move on with their lives.
For homeowners who saw the value of their properties grow substantially during the pandemic housing boom, seeing those gains potentially fall away will be a painful process, particularly if they hope to move in the next year. Currently the major mortgage lenders are predicting a fall in house prices of up to 10 per cent over the year. Ultimately this will depend on the listed price.
Whilst buyers and sellers pressed the Christmas pause button several weeks early last year after the mini-Budget spread political uncertainty and caused mortgage rates to spike, the re-activation of plans I the New Year should bring success to the vendors willing to move.
COMMERCIAL PROPERTY
The commercial property sector is operating within the context of the second economic contraction in three years, a rapid rise in the cost of debt and high inflation, together with the ongoing long-term structural shifts in demand precipitated by the pandemic.
The Autumn Statement contained a package worth £13.6 billion to help business rates payers, with a commitment to introducing new valuations of properties to reflect more recent market conditions from April 2023, plus a package of relief measures.
In its Q3 2022 UK Commercial Property Survey, the RICS reports an aggregate net balance of -10% for tenant demand, a significant deterioration from the +17% in the Q2 survey and +32% in Q1. Occupier demand fell for both retail and office space, with balances of -37% and -22% respectively.
However, industrial occupier demand remains in positive territory at +21%, albeit down from +49% in Q2.
The survey reports that both the office and retail sectors continued to see a rise in availability, but supply in the industrial market continued to tighten, albeit modestly. Respondents to the RICS survey expect prime office rents to be broadly flat over the next year, but a significant balance expect a fall in secondary office rents. A significant balance expects a fall in retail rents, whilst a modest balance expects industrial rents to rise.
Overall, the commercial market remains characterised by a dearth of the quality supply that occupiers now require in sectors such as offices (key city centres), last mile delivery and distribution warehousing. With developers facing elevated building costs, supply chain challenges and economic uncertainty, we do not expect a significant increase in construction levels, and the lack of stock will continue to act as a constraint on take-up.
OFFICE OCCUPIER MARKET:
High inflation is creating greater cost pressures for corporates, which is likely to further increase the focus on cost reduction and productivity. Although corporate real estate is the second highest cost after salaries for many businesses, the provision of high-quality space can also help to increase productivity. This, together with the longer-term impacts of the working from home revolution, means that many businesses continue to assess their real estate footprint, and are placing an ever-greater emphasis on smaller but higher quality space.
Whilst there is a large quantity of office stock available, much of it does not meet the requirements of today’s occupiers, and a two-tier market is increasingly apparent.
In many locations, a shortage of quality space rather than occupier demand is holding back take-up, and the modest amount of speculative development in the short-term pipeline is unlikely to change this picture.
Despite uncertainties around future levels of office occupation, we have not seen any falls in prime rental levels in our key locations. Indeed, many major city centres have seen prime rents continue to climb and are above their pre-pandemic levels.
The resilience of prime rents reflects the increasing focus of occupier demand towards top quality space, driven by the desire to create a vibrant and attractive work environment to encourage employees back to the office and assist with recruitment, retention, and productivity strategies, as well as staff health & wellbeing issues. In addition, there is a greater focus on buildings that are sustainable and energy-efficient, as occupiers try to meet increasingly ambitious ESG aspirations.
The current dearth of new development will mean continued upward pressure on prime rents, and the gap with rents for poorer quality grade B stock is likely to widen further.
Many owners in smaller towns and city suburbs have been taking advantage of permitted development rights over the past decade and have converted empty secondary office buildings into alternative uses (especially hotels and residential), which has meant that many markets have lost office stock on a net basis in recent years. This trend is likely to continue, especially as new environmental regulations will make many office buildings unoccupiable in the coming years and will reduce the overall supply.
Following only modest falls during the pandemic, average UK office rental values have increased by 1.3% from February 2020 to November 2022 (MSCI Monthly Index). Average office rental values have seen a steady increase over last few months, rising by 0.3% in the three months to November.
Average rental value growth for all offices in the 12 months to November 2022 was 0.6% in the City of London, 1.3% in London mid-town and the West End, 0.8% in the rest of the Southeast, and 1.5% in the rest of the England (MSCI).
INVESTMENT MARKET
VOLUMES
UK commercial property investment transaction volumes fell in Q3 2022, driven by the office and alternative sectors. However, activity in the industrial and retail sectors was resilient compared with recent quarters.
£11.8bn was traded in Q3 2022. This was down 28% quarter-on-quarter, 17% below the five-year quarterly average and was the weakest quarter for investment since Q1 2021. Notably, thanks to three stronger previous quarters, the rolling annual total remained 21% above the five-year average, at £69.8bn.
Investment in London (excluding multi-regional portfolio deals) accounted to 40.3% of the UK total, which was broadly on par with Q2 2022 but well below the five-year average of 51.3%. The ‘flight to quality’ accelerated by the pandemic continued to be a theme in the capital, especially in the office sector. Overseas capital drove volumes in London, accounting for 65.5% of the total, while in the regions, the share of overseas investment was 42.4%, an increase from 32.4% in the previous quarter. 59% of all investment took place in the regions in Q3 2022, above the five-year average of 50%.
The office and the industrial sectors still accounted for the largest share of the quarterly UK total investment, with 26.2% and 30.3% respectively. However, investment in offices was further below the 5-year average than any other sector. Notably, investment in retail amounted to 16.9% of the total, the highest share since Q2 2019.
INVESTMENT PERFORMANCE
All property equivalent yields experienced a downward shift as the pandemic receded, from a peak of 6.3% in 2020 to 5.1% in June 2022. This was led by the industrial sector, as it experienced burgeoning occupational demand amid limit supply, with the retail warehouse sector also seeing a marked downward yield shift, due to its resilience compared with the broader challenging retail backdrop.
The period of downward yield shift in these sectors is now firmly over, with commercial property now seeing yields move upwards almost across the board, as investors have reassessed their risk assumptions following the rapid rise in long and short-term interest rates, and weaker outlook for economic growth. The industrial sector has seen a sharper correction in values than the commercial market, despite the positive occupier story and resilience of rental values. The MSCI all-property equivalent yield has risen from a low of 5.15% in June 2022 to 6.27% as a November 2022, an upward shift of 113 basis points.
The UK 10-year gilt yield had been on an upward trend even prior to the Government’s ‘mini budget’, which was the catalyst for a marked upward shift, with yields peaking at 4.6%. As of 19 December, the 10-year gilt yield was 3.5%, a little above level seen just prior to the mini budget, but still in marked contrast to 1.0% at the start of 2022 and lows of under 0.2% in 2020.
Gilt yields have shifted upwards more rapidly than property yields, and so the yield gap has narrowed. In October 2021, the yield gap was 460 basis points, compared with 280 basis points as at the end of November 2022.
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