Capital Markets Review Q3 2020

  • Total returns return to positive territory in Q3, despite capital losses of 0.7%
  • Investment volumes have improved but remain firmly below the long run average
  • Second wave lockdown, and a disruptive collapse of the Brexit trade talks, could see the market fall further.

The combined fall in output in March and April amounted to -25.3% but was shallower than expected. UK GDP has now grown month on month since the end of April but remains 9.2% lower than the levels achieved in February before the full impact of COVID-19. The pace of the recovery is now decelerating.

UK GDP is projected to continue to recover over the next two-years but the rate of recovery will depend on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors.

Since the end of the first lockdown, there has been a strong recovery in physical retailing compared to a slow return to the workplace as “WFH” becomes the new normal, at least for now. Tellingly, those cities that witnessed a quicker return to the workplace are the very same cities that were categorised as “Very High Risk”.

All Property total returns returned to positive territory in Q3 at 0.7% as an income return of 1.4% offset a capital loss of -0.7%. All Property equivalent yields were largely stable and had a neutral effect on valuations. The main driver of falling values has been declining market rental values.

All Property investment volumes increased by 35% in Q3 off a very low base in the previous quarter but nevertheless remained 56% below their long run average. Stricter regulation of bank lending and demands for redemptions by property fund investors have limited market liquidity.

UK real estate values might not fall as far or as fast as initially expected at the outset of the pandemic. But the recovery stage of the crisis is likely to be prolonged. Second-wave lockdown and a disruptive collapse of the Brexit trade talks could of course see the market fall further.

Many column inches continue to be devoted to the future of offices. Fewer employees working from city centre offices may reduce the demand for space. But social distancing requirements will pull in the opposite direction and may oblige businesses to take on more space.

Out-of-town business parks could see a resurgence in demand as city centre offices remain largely empty and private transport is preferred to public transport. City centre vacancy rates will not rise sharply but there will be an increase in the amount of unoccupied or under-utilised grey space. However, any structural change to the office market will play out over many years.

The huge growth in online shopping and home working may damage some segments of the real estate market. But it will increase the demand from investors and occupiers for large warehouses or fulfilment centres and last mile logistics units. It is also possible to argue the case for suburban co-working space and data centres to support home workers.

Brexit continues to pose a threat to the UK economy and therefore its real estate market. The transitional arrangements under the Withdrawal Agreement end on 31 December and so far, no new agreement with the EU has been negotiated. In the absence of an agreement the UK will be forced to trade with its closest and largest export market on WTO terms; or an Australia style agreement according to the euphemism used by the government.

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