Report on the overall Covid-19 economic impact by Avison Young, Real Estate Agents
This report looks at economic trends, UK GDP growth, the labour market, inflation and interest rates, investment market, commercial property occupation and the future outlook.
The impact of Covid-19 will be the main driver of economic performance in the near term and we expect dramatic decline GDP in Q2. Despite the monetary and fiscal measures being enacted to combat the economic fallout of the virus, it is strongly anticipated that the UK will enter a deep recession in 2020 which could exceed that observed in 2008-09. There is however hope that recovery will be quicker due to the cause being a market shock rather than a structural issue.
Longer term, the UK has now entered the next phase of Brexit negotiations, following the official departure from the European Union on 31 January 2020. Whilst uncertainty around the timing of Brexit has lifted, there remains a high level of uncertainty surrounding UK’s future relationship with EU, particularly in terms of trading.
UK GDP growth flatlined in Q4 2019, albeit preliminary figures indicate annual GDP growth for 2019 was 1.4%. . GDP growth for the three months to January 2020 was also flat, suggesting that the potential post-election ‘Boris-bounce’ did not materialise. The spread of the Covid-19 disease will continue to cause huge disruption to business activity and have a dramatic impact on the economy in at least the short-term. Significant repercussions are already visible across liquid asset classes.
Beyond Covid-19, the March 2020 budget made commitment to spending increases over the next five years that should boost economic growth and provide defence against the economic uncertainties from Brexit, particularly around trading relationships. The extra public investment takes government spending to 3% of GDP, a level not seen on a sustained basis for decades.
The Markit / CIPS Purchasing Managers Indices for services declined at the fastest rate since the measure was introduced, falling to 34.7 from 53.2 March to February. The manufacturing PMI was also down in March, decreasing to 47.8 from 51.7 in February. These falls come off the back of positive growth earlier in the year. Construction PMI scores are yet to be published for March, with the latest figure being 52.6 in February.
The labour market remained buoyant for much of last year with the employment rate reaching a record high of 76.5% at the end of 2019. Real earnings increased by 1.8% (excluding bonuses) for the third consecutive month. However, forward looking indicators suggest the job market is cooling. Covid-19 is expected to push unemployment up to 6% from 3.9% as businesses struggle to meet staff requirements with significantly curtailed incomes. In the two weeks from 16 March, 950,000 successful universal credit applications were made. A usual figure for this period would be around 100,000 applications.
Inflation fell slightly to 1.7% in February, down from 1.8% in January. Inflation is likely to remain below the Bank of England’s 2% target in 2020. The Bank of England (BoE) cut interest rates to 0.1%, following earlier cuts as exceptional measures in, to combat the negative impact of Covid-19.
Outlook – Covid-19 escalation will significantly hit economic growth, with a deep but potentially short-lived recession forecasted. However, fiscal stimulus from the Budget and the emergency interest rate cut are likely to go some way to mitigating impact. Capital Economics most recently forecasted GDP growth at -9% for 2020, revised down from -7% two weeks previously and down on their original 1% forecast at the beginning of the year.
In terms of Brexit, businesses now appear to be more confident, albeit they remain wary of the potential headwinds facing the UK. Recent comments from Boris Johnson suggest the UK’s strategy is to aim for a Canada style agreement, rather than a closer Norway style relationship with the EU.
Central London office take-up totalled 12.3 million sq ft in 2019, following a strong performance in Q4. This is one of the strongest years on record and only just surpassed by 2018’s 12.5 million sq ft. The limited supply and high demand has placed considerable pressure on rental levels throughout Central London. Rents for the most sought after spaces in the City continue to surpass previous benchmarks and in some instances achieve levels comparable to the West End.
Total take-up across the Big Nine office markets amounted to 8.8 million sq ft in 2019, 3% above the ten year average albeit below the 10 million sq ft achieved in the previous two years. The heightened uncertainty surrounding Brexit and false deadlines resulted in the total being down on the previous two years but comparable to 2016.
Covid-19 will exacerbate the structural challenges faced by the retail market, despite the exceptional measures to mitigate impact. The Centre for Retail Research estimated over 143,000 jobs losses in 2019 as a result of more than 16,000 stores closing. Unfortunately 2020 is unlikely to be any better for the retail market as the CRR suggests that over 20,000 stores may not reopen when government restrictions have been lifted. Reflecting the difficult conditions, average retail rental values fell by -4.7% in 2019, down from -2.6% in 2018 (MSCI Monthly Index).
Demand for the industrial property continued to rise, albeit at a slower pace last year. Recently, supermarkets and discounters have set significant requirements for logistical facilities across the UK to cope with the additional demand from Covid-19. However, looking forward, supply chain disruptions from Covid-19 will impact the industrial and warehouse sectors.
Longer term, the sector continues to be underpinned by the growth in e-commerce which could be further accelerated by trends adopted during the lockdown. However, the slowdown in the global economy and Brexit uncertainty have weighed on the sector to some extent. Average rental growth increased by 3.1% in the 12 months to December (MSCI Monthly Index). This is robust but it’s a slowdown from the circa 4% pa growth seen in the previous three years.
Outlook – Longer term, the changes that businesses, government and individuals will implement during the Covid-19 crisis will accelerate some trends already evident in the market, including deglobalisation of supply chains, a shift towards online retail and flexible working practices in the service sector.
Investment activity in the UK commercial market achieved £11.8 billion in Q1 2020 (Property Data). Although down on the 5 year quarterly average, this figure was marginally up on the same period in 2019. Overseas investors accounted for almost 50% of the quarter’s investment activity.
While some deals which were already in their late stages have completed, it is unlikely that investors will have new interests until the economic outlook is clearer, adopting a wait and see attitude. Financers are also unlikely to offer funds in the absence of accurate valuations due to the exceptional circumstances. Hence lockdown restrictions are likely to have notable impacts on Q2 investment at least.
All-property equivalent yields have edged up to 6% amid weak economic outlook and stress in the retail property sector. Consequently, all-property average capital value growth fell further negative to -3.0% in the year to December (MSCI Monthly Index), down from 2.1% a year earlier.
Outlook – Investment activity suffered as a result of Brexit uncertainty. The increased clarity in recent months is a positive for investors although concerns remain over the nature of our future relationship with the EU. Covid-19 will have a short term impact on activity – particularly through the lack of valuation capacity as site visits are suspended, comparable evidence is limited and market uncertainty reigns – but long-run demand will remain. There is significant appetite in the market and considerable amounts of capital to invest, primarily in the industrial and office sectors, hence investments are likely to be postponed rather than pulled entirely. Challenges in the retail sector are likely to remain in the year ahead and we expect capital values to deteriorate further.