Market in Minutes:
UK Commercial – June 2017

UK Commercial Market in Minutes
UK Commercial

6 June 2017, words by Marie Hickey

Weight of money maintaining pricing

Number of sectors noting improved investor appetite increases

■ There was no change in prime yields in April or May. What did change was the number of sectors reporting downward pressure. March saw five sectors with downward arrows, which increased to six in April and May with Foodstores added to the list (see Table 1 below).

 

TABLE 1

Prime yields

 
Table 1

Source: Savills Research

■ While this is little to write home about, it does highlight the continued appetite for UK real estate in the face of Brexit. This is apparent in Q1 transaction volumes which totalled £12.8bn, largely driven by activity in the London office and industrial markets, 20.5% higher than the 10-year first quarter average.

■ The weaker pound post the EU referendum has renewed overseas investor interest in UK real estate, particularly those from Asia Pacific. The rolling 12-month total for overseas investment was up 4.9% on a quarterly basis in Q1 with activity from Asia Pacific investors up 22.1%. UK acquisition volumes by this group totalled £2.9bn in Q1, almost double that reported in Q1 2016 and is the highest quarterly total seen since Q4 2013.

■ With currency forecasts from Oxford Economics suggesting that the pound will remain relatively weak against the euro and dollar over the short term, overseas investor interest in the UK will continue over the course of 2017.

■ The weight of money from overseas investors is helping to maintain current pricing and may even translate into yield compression in some sectors over the remainder of 2017. This is also being supported by the amount of undeployed capital sat in PE funds. Dry powder for private equity (PE) real estate funds reached a new high in March of $247bn, with $63bn of this related to European funds (see Graph 1).

GRAPH 1

Weight of money targeting real estate remains at all time high supporting pricing

 
Graph 1

Source: Savills Research, Prequin Real Estate

Foodstores back on the shopping list

■ Foodstores were added to the list of sectors experiencing downward yield pressure in April and is one where we expect yield hardening to materialise over the course of 2017 due to increasing investor appetite.

■ This compression would be on the back of some relatively difficult years where negative newsflow surrounding operational performance across the 'Big Four' saw yields drift out in 2014.

■ Operator performance has since improved, yet prime yields have not seen the corresponding downward shift and remain 50 to 75 basis points off their previous 2014 low (see Graph 2).

GRAPH 2

Foodstore prime yields (OMR vs RPI)

 
Graph 2

Source: Savills Research

■ However, it is not just improved operator performance that is luring investors back. The residential play on under-utilised foodstore sites in Greater London and the South East is an additional driver. The long inflation linked leases common to the sector have also added to its attractiveness particularly as the appetite for 'risk' has waned in the aftermath of the Brexit vote. For example, almost 60% of 2016 transactions were on assets with inflation linked leases (RPI or CPI) with prime yields on these assets in the region of 25 to 75 basis points lower than OMR linked stores.

■ The relationship between operational performance and yields in the foodstore sector does suggest some of the investor caution currently seen in other parts of the retail market should dissipate once trading conditions improve.

Penetration of online slowing

■ While retail sales, both in value and volume terms, have improved in recent months the growth in online continues to have significant bearing on brick-sand-mortar retailing. This has been recently exacerbated by the Business Rating revaluation.

■ What is becoming increasingly clear is that its not just a case of offline vs online. Rather the 'store' continues to play an important role in driving brand awareness, and even online sales. This is reinforced by the fact that some pure-play e-tailers are making the transition to physical retailing.

■ The slowing growth in online, plus low online penetration rates in some parts of the retail market, means physical retailing will continue to dominate. For example, GlobalData Retail forecast that online will account for 18.4% of retail sales by 2022 (see Graph 3). In the case of Health & Beauty retailing only 11.5% of sales will be online.

GRAPH 3

Online sales growth slowing

 
Graph 3

Source: ONS, GlobalData Retail

■ Where online is perhaps having the biggest impact is in terms of the number and size of stores required, plus how retailers are using this space. For investors this trend is likely to result in a refocus on more resilient retail markets. It will also require greater awareness of the type of space required by retailers and how this may differ across markets. Perhaps the real challenge for landlords, and retailers, going forward will be determining the value of a given store.

 
 

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Key contacts

Marie Hickey

Marie Hickey

Director
Commercial Research

Savills Margaret Street

+44 (0) 20 3320 8288

 

Mark Ridley

Mark Ridley

Chief Executive Officer
Savills UK & Europe

Savills Margaret Street

+44 (0) 20 7499 8644