Real Estate

Deloitte Insight

Q1 2015

Prospects remain positive

Property IQ

AuthorsJames GriggsInformation Unit Managerjgriggs@deloitte.co.uk+44 (0)20 7303 3158

Will MatthewsHead of Researchwmatthews@deloitte.co.uk+44 (0)20 7303 4776

The 2015 property market has a hard act to follow. Last year, everything fell in place to produce an exceptional performance in a heated investment market. But in fact many of the factors that contributed to that result have not disappeared, and in some cases have even improved.

For a start, expectations for GDP growth this year have been edging up. Following a softer patch in Q4, PMI business surveys in January indicated that service sector and construction activity accelerated again, and the latest data for overall business investment is showing annual growth of 6.4%, suggesting further output growth to come. The Bank of England has maintained its fairly bullish forecast of 2.9% GDP growth this year.

Meanwhile inflation has fallen sharply, CPI reaching a record low of 0.3% in January, and is expected to drop below zero for a short period during the first half of the year.

Cheaper energy and other costs will provide a further boost to businesses and to the UK economy generally, mainly through increasing consumers’ spending power. A further effect has been that the expected point when the base rate will start to rise has been pushed further back. The Bank of England’s latest Credit Conditions Survey points to higher demand for credit from medium and large companies, and the cost of credit continuing to fall for these types (though for small companies this is not the case).

Regions improvingWe can see evidence of this improving position filtering through in employment numbers and commitment to new real estate floorspace. Job creation in the regions has been growing faster than in London, while take-up of office space in most of the major regional cities, as well as in the capital, was significantly higher in 2014 than during the previous year.

Source: Deloitte Real Estate

Sector Category Sep

‑09

Oct

‑09

No

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pri

‑14

May

‑14

Jun

‑14

Jul‑

14A

ug

‑14

Sep

‑14

Oct

‑14

No

v‑14

Dec

‑14

Jan

‑15

Shops

Prime major cities

Cathedral cities

Market towns

Shopping centres

Regional dominant

Sub‑regional

Major town centre schemes

Smaller urban schemes

Retail warehouses

Parks (open A1)

Parks (bulky)

Solus

Car showroomsLet to dealership

Let to manufacturer

Leisure parks

Supermarkets Standalone superstore

Industrial

Distribution (15 year term)

Distribution (5 year term)

Modern ind. est. (Regional)

Modern ind. est. (South East)

Offices

City

West End

Midtown

West London

South East

Major cities

Out‑of‑town

Deloitte Real Estate Yield Matrix – changing sentiment towards yields on prime propertyWeaker sentiment has spread from supermarkets to some other parts of the retail sector

Sentiment indicator: n Sentiment weakening n No change in sentiment n Sentiment strengthening

From an investor’s point of view, what is likely to reduce the attraction of UK commercial property? In effect, perhaps very little. Low real estate yields remain attractive in relative terms in a world of low government and corporate bond yields, and the UK economy looks strong compared with others. The UK’s GDP growth outlook was notable in not being downgraded by the IMF in January as many others were and only the US forecast was raised. This should support further rental growth. Certainly the market does not seem to have paused for breath after Q4’s record volume of deals: to the end of February, total investment this year was more than 18% higher than during the same period last year.

Political risksThe most prominent current downside risks are political. Most immediately, May’s general election carries a much higher degree of uncertainty over policy direction than is usual. This will mainly affect domestic investors, some of whom may defer purchases in the interim; overseas investors however are likely to be more immune. Further off, but potentially of greater concern, lies the potential for a referendum on the UK’s EU membership.

The make-up of overseas investors targeting the UK markets is constantly changing. The US recovery appears to be fully under way, and the effect of the strengthening US dollar is already evident in the increasing volume of investment activity by US funds. Meanwhile the slump in oil prices could affect oil exporting countries’ demand for UK property – so far this has been minimal but weaker currencies could in time lead to reduced spending power.

Sector performance wideningTurning to the performance of the different parts of the property market, our Yield Matrix sentiment table on the previous page shows that some parts of the retail sector have now turned from green to amber, indicating a stable rather than an improving view, while sentiment in the supermarket subsector remains negative. Retail was the last sector to join the recovery, and where sentiment is turning, will have had less time to build performance through the cycle than the other main sectors.

This relative weakness in the retail sector is apparent in the performance data. Annual total returns (chart 1)show a clearly widening spread among the sectors over the last three years. While in September 2012 there was little more than two percentage points between the best and worst performing sectors, in December 2014 that gap had grown to over eight percentage points, with office and industrial well above the average and retail and ‘other’ well below it.

Chart 1. Total returns, annual %

0

5

10

15

20

25

Dec

-14

Sep-

14

Jun-

14

Mar

-14

Dec

-13

Sep-

13

Jun-

13

Mar

-13

Dec

-12

Sep-

12

Jun-

12

Mar

-12

Retail Office Industrial Other

All Property

Source: MSCI/IPD

Chart 2. Annual total returns by security of income %

Source: MSCI/IPD

0

5

10

15

20

25

30

Dec

-14

Sep-

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Jun-

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Mar

-14

Dec

-13

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Dec

-12

Sep-

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Jun-

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Mar

-12

Standard retail – longest unexpired leasesStandard retail – shortest unexpired leasesCentral & Inner London offices – longest unexpired leasesCentral & Inner London offices – shortest unexpired leases

Secondary assets in the London and South Eastern office markets are now outperforming prime property, as investors buy into the potential returns suggested by rental growth prospects. The chart above shows that central London offices with shorter leases to run – and therefore better placed to take advantage of rising rents – are now producing significantly better returns than those with longer unexpired lease terms. However, in the retail sector the opposite is the case, with income security still key.

Property IQ Prospects remain positive2 |

The economy

Growth at home, but with political risksUK growth outlook remains solid

• The 0.5% growth reported for the economy in Q4 suggested the UK had hit a softer patch. However, boosted by the effects of a sharp drop in oil prices, output is expected to pick up and lead to a further year of solid growth – not least by the Bank of England which confirmed its 2.9% growth forecast in its recent Inflation Report.

• Compared with almost all other developed economies except the US, this represents a strong performance. GDP growth in the States is expected to lead to the Federal Reserve raising bank rates at some point this year; other European countries are facing the prospect of monetary tightening – Sweden being the latest to cut its rate – while the ECB announced its €60bn-a-month quantitative easing programme in January.

Regional activity continues to expand

• Encouragingly, the regional economies are part of the UK growth story: activity survey data from private firms over the final quarter of 2014 showed output growing in all regions, with the South East, West Midlands and Wales recording the fastest expansion.

• PMI employment growth is currently strongest in the Eastern region, while the North West saw close to 200,000 new jobs created during 2014.

Political uncertainty seen as largest risk

• The biggest drag on this largely positive picture appears to come from the uncertainty over policy following the general election. Respondents to the latest Deloitte CFO Survey picked this as their number one risk, with the prospect of a referendum on EU membership sitting alongside general economic weakness in Europe at number two.

• As a consequence, in Q4 the overall perceived level of external financial and economic uncertainty among large corporates rose to its highest in a year.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Changing consensus forecasts for GDP growth

Jun-14

Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14

Jan-14

Jan-15

Feb-14 Mar-14 Apr-14 May-14

Forecasts made in:

Source: HM Treasury

GD

P gr

owth

%

2014 2015

Risk to business posed by the following factors

Source: Deloitte CFO Survey

Weighted average ratings on a scale of 0 –100 where 0 stands for no risk and 100 stands for highiest possible risk

2014 Q3 2014 Q4

40 45 50 55 60 65

The prospect of higher interest ratesand a general tightening of monerary

conditions in the UK and US

Weakness and/or volatilityin emerging markets

A future UK referendum onmembership of the European Union

Deflation and economic weaknessin the Euro area,and the possibility

of a renewed Euro crisis

The May 2015 UK General Electionand the risk of policy change and

uncertainty

63

50

56

49

56

50

49

45

46

47

North West

East Midlands

PMI business activity, December 2014

Source: Markit

North Ireland, 49.8

North West, 54.1

Wales, 56.9

West Midlands, 55.7

Scotland, 52.8

North East, 56.9

Yorkshire & Humber, 55.3

East Midlands, 56.3

East, 55.6

London, 56.7

South East, 56.3

South West, 55.0

| 3Property IQ Prospects remain positive

UK commercial property

Overseas money drives investment to a new high

Record quarter seals a record year

• Investment deals totalling over £21bn in the final three months of 2014 – the highest quarter ever – pushed the total for the year to a new record, ahead of 2006.

• The desire among funds to commit large amounts of cash quickly to UK property led to a surge in portfolios transacting in the second half of last year, with a higher average size than those sold in 2013.

Overseas investors dominant in Q4

• US funds made a strong re-entry into the UK market during the second half of 2014, lifting overseas buyers’ share of the market to just under half in the last quarter of the year.

• UK institutional funds have also been keen to increase their exposure to commercial property, recording strong net investment over the whole of 2014. Property companies, in contrast, have been trading more actively, and have been on balance net sellers over the last three quarters. Financial investors – mainly banks –increased their rate of selling off assets in Q3 and Q4 last year.

Institutions more focused on regional property

• Overseas buyers have been generally concentrating on the central London markets and London more broadly, with a particular interest in office stock. In contrast, UK pension and insurance funds made the bulk of their acquisitions last year outside the capital, with much less concentration on the office sector and more on retail and industrial.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Property investment by quarter (£ million)

Q3 Q4Q1 Q2

Source: Property Data

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Share of investment by investor type Q4 2014

Source: Property Data

2%3%

49%

2%

26%

18%

Owner occupiers

Overseas investors

Private investors

UK institutions

UK property companies

Others

02,0004,0006,0008,000

10,00012,00014,00016,000

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Overseas investors and UK institutional funds: 2014 purchases (£m)

Overseas investors

Source: Property Data

UK instutional funds

Sectors Regions

Property IQ Prospects remain positive4 |

UK commercial property

Regions and industrial in the spotlightRegions cut a larger slice

• Among the main features of the investment market last year was the increased share of transactions in the regional markets, up from 35% in 2013 to 47%. To an extent this was fuelled by the surge in interest in portfolio sales (volumes up 47% year-on-year) most of which lie outside the capital. But predominantly this illustrated the increased investor confidence in seeking the higher returns available the regional markets.

• The strongest year-on-year growth in activity came in the West Midlands and Scotland, while Manchester led among the major city office markets.

Industrial yields pushed down

• Industrial property enjoyed a remarkably strong 2014: yields tumbled 125bps on prime regional estates and distribution warehouses saw similar compression, again 125bps on shorter-leased assets with higher rental growth prospects.

• Q4 of 2014 saw over £1.9bn of industrial stock sold, the highest total since the peak of the last cycle. Just over half of these were single-let assets – mainly warehousing – while industrial portfolios were offered in increasing numbers towards the end of the year. A total of 37 industrial portfolios changed hands during the year with a total value of £1.8bn.

Retail returns struggling

• In contrast, retail has been the weakest of the main broad sectors, producing an annual total return in Q4 of 14.0%, against 22.3% for offices and 23.1% for industrials. But performance within retail has been very varied: central London unit shops achieved the best annual returns among all the IPD segments, and supermarkets the worst.

• There remains a distinct split between high street vacancy levels in the South East and the rest of the UK, and the over-supply of space in many regions is holding back rental growth. That said, prospects for consumer spending are improving. The latest Deloitte Consumer Tracker showed discretionary spending at a three-year high.

Prime industrial yields

Source: Deloitte Real Estate

Prime distribution 5 year assumed termModern industrial estate regional

Modern industrial estate south east

%

4.04.55.05.56.06.57.07.58.08.59.0

Sep-

14

Mar

-14

Sep-

13

Mar

-13

Sep-

12

Mar

-12

Sep-

11

Jun-

11

Jun-

12

Mar

-11

Sep-

10

Dec

-10

Dec

-11

Jun-

13

Dec

-12

Jun-

14

Dec

-13

Dec

-14

Retail total returns, month-on-month %

Source: MSCI/IPD

High street shops Shopping centres Retail warehouses

%

-1.0-0.50.00.51.01.52.02.5

Dec

-14

Jun-

14

Dec

-13

Jun-

13

Dec

-12

Jun-

12

Mar

-12

Sep-

12

Mar

-13

Sep-

13

Mar

-14

Sep-

14

Regional share of investment

London SE, Eastern Midlands, SW

NE, NW, Y&H Scotland, Wales, NI

Source: Property Data

0

20

40

60

80

100

2014201320122011201020092008200720062005

| 5Property IQ Prospects remain positive

UK commercial property

Limited new office space will put upward pressure on regional rents

Office supply remains tight in the regions

• The volume of new office space in the regional office markets remains squeezed.  Supply in Leeds and Manchester last year was up significantly on 2013, but while Leeds surpassed its long-term average delivery, Manchester was still below, and is expected to be so for the next two years.

• As a consequence, with strong occupier demand for new space, the pressure will be on rents to rise over the coming phase. Already our Leeds Crane Survey has recorded three speculative office schemes that have started on site.

Improving prospects for 2015

• Following IPD’s 2014 total return of 17.9% – the best since 2006 – the consensus view is that with far less yield compression in prospect, capital growth will fall back and despite an improving rental picture, returns will follow suit.

• But we believe that returns will not be that much lower this year than last: the strength of investor demand, with yields to come down further in some sectors, should produce a further year of above average performance.

Hotels move further into the investment limelight

• The growth in investment in property outside the three main sectors has been a notable feature of the recent market, and hotels have shared in this increase in interest, with total investment rising from £2.2bn in 2013 to £4.3bn last year.

• On the operational side, improved regional economic conditions are reflected in the rise over the year to Q4 2014 in the average daily rate charged across all major cities. Glasgow saw the strongest annual growth, up 17%.

• While new supply is currently fairly muted, the budget end of the market is set to see further expansion mainly around London and the South East.

Office development pipeline: Leeds & Manchester

Source: Deloitte Real Estate

Leeds Completed

Average

Million sq ft

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Manchester Completed

Leeds U/C Manchester U/C

£0£20£40£60£80

£100£120£140£160

Man

ches

ter

Leed

s

Gla

sgow

Edin

burg

h

Car

dif

f

Bir

min

gham

Lond

onUK

Hotels: average daily rate

Source: STR Global

Q4 2013 Q4 2014

-25

-20

-15

-10

-5

0

5

10

15

20

Total return outlookAnnual total returns %

RangeIPD historic IPF consensus central forecast

Source: IPF Consensus Forecast Report November 2014

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Source: IPF Consensus Forecast Report February 2015

Property IQ Prospects remain positive6 |

Recent publications

UK Futures:Businesses Leading Britain 2014:

A new lens on growth

London Office Crane Survey Winter 2014: Building

momentumThe London Business Footprint: Mapping change in the office

market

London Futures: Agiletown – the relentless march of technology and London’s

response

Q4 2014

January 2015

The Deloitte CFO SurveyAuthorsIan StewartChief Economist020 7007 9386istewart@deloitte.co.uk

Debapratim DeSenior Economic Analyst020 7303 0888dde@deloitte.co.uk

Alex ColeEconomic Analyst020 7007 2947alecole@deloitte.co.uk

ContactsIan StewartChief Economist020 7007 9386istewart@deloitte.co.uk

Mark FitzPatrickVice Chairman and CFO Programme Leader020 7303 5167mfitzpatrick@deloitte.co.uk

For current and past copies of the survey, historical data and coverage of the survey in the media and elsewhere, please visit:

www.deloitte.co.uk/cfosurvey

2015: Growth in an uncertain worldPolicy uncertainty at home and economic and geopolitical risks overseas are the central challenges facing the UK’s largest companies as they enter 2015. Concerns about policy change after May’s General Election have risen significantly and this is seen as the biggest risk facing UK business in 2015. Chief Financial Officers rate deflation and weakness in the euro area as an increasing concern and the second greatest business risk. A UK referendum on European Union membership and emerging market weakness rank as the third and fourth most prominent business risks. Again, CFOs believe that the level of threat posed by both has risen over the last three months.

This marks a big shift in thinking. Going into each year, from 2008 to 2013, CFOs’ main concern has been the state of the UK economy. Now the risks are seen as lying elsewhere and CFOs are upbeat on the UK’s economic fundamentals. Unlike policymakers, a clear majority of CFOs are not especially concerned by the UK’s productivity record and they overwhelmingly see the UK as a “good” or “excellent” place to do business. Corporates believe that the long consumer squeeze has ended. On average, CFOs expect wages in their businesses to rise by 2.9% in 2015. With inflation likely to run at the 1.3% mark, real earnings look set to register the first annual increase in eight years in 2015.

Nonetheless, rising levels of uncertainty have fed through to a weakening of corporate risk appetite. 56% of CFOs say now is a good time to take risk onto their balance sheet, down from a peak of 71% in the third quarter – though still well above the long‑term average. Cost control is CFOs’ top balance sheet priority for 2015, but CFOs also expect business investment to remain buoyant. On average, CFOs expect their investment in the UK to rise by 9% in 2015, following growth of about 8% in 2014. That would put the UK at the top of the league for investment growth in the major industrialised nations. If realised it will take the share of UK GDP accounted for by business investment to the highest level in 15 years by the end of 2015.

The UK General Election and economic uncertainty overseas are central concerns for UK business. But at home CFOs expect 2015 to be a year of investment and of recovering real earnings. Corporate and consumer spending look set to lend the UK economy important support, suggesting the UK will post decent growth through 2015.

Chart 1. Risk to business posed by the following factorsWeighted average ratings on a scale of 0 – 100 where 0 stands for no risk and 100 stands for the highest possible risk

40 45 50 55 60 65

The prospect of higher interest rates and a generaltightening of monetary conditions in the UK and US

Weakness and/or volatility in emerging markets

A future UK referendum on membership of theEuropean Union

Deflation and economic weakness in the euro area,and the possibility of a renewed euro crisis

The May 2015 UK General Election and therisk of policy change and uncertainty

2014 Q3 2014 Q4

5063

4956

50

56

45

4647

49

40690A mww CFO Survey Q4 2014.indd 1 09/01/2015 12:26

Deloitte CFO Survey Q4 2014 London Industrial: Taking stock of the capital

Q4 2014

Deloitte Insight

Discretionary spending hits three‑year highThe latest Deloitte Consumer Tracker shows that an improving labour market and falling inflation are having a pronounced effect on consumer spending behaviours.

In Q4 2014 fewer people suffered a reduction or a loss of income and more people said they had received a pay rise than a year ago. These factors, coupled with low inflation, are underpinning consumers’ confidence in their level of disposable income, which remained stable for the third consecutive quarter.

With the Consumer Price Index continuing to fall, reaching its lowest in 14 years in December, disinflation is providing a strong boost to consumers’ finances. The Tracker shows that falling prices for essentials, including food, energy and petrol, are freeing more disposable income for discretionary and big ticket purchases.

Categories benefiting from the increase in discretionary spending, and which have registered the strongest increase in net spending this quarter, include hotels and restaurants, major household appliances and consumer technology. Net spending on utilities and groceries is growing more slowly than consumer spending overall, reflecting falling fuel prices at the pump and intense price competition in the grocery sector.

Overall consumer confidence in the fourth quarter was three points higher than a year ago. The long‑term upward trend continued with a net improvement in confidence in 2014 compared to 2013.

While the long‑term trend in confidence is up, short‑term uncertainties have mounted. In Q4 2014, confidence fell three points when compared with the previous quarter. This dip reflected weaker sentiment about health and wellbeing, and job security.

The impact of external factors depressing confidence is echoed in Deloitte’s latest survey of chief financial officers. While CFOs expect 2015 to be a good year for their own businesses, they are concerned about external factors such as the UK General Election and economic uncertainty overseas.

Looking ahead there is likely to be more good news for consumers, as real wages are expected to continue to recover. Deloitte’s survey of CFOs shows that they anticipate employee earnings in their businesses to rise significantly faster than inflation this year.

A recovery in disposable incomes in 2015 seems likely to shift consumers to more expansionary spending behaviours and to drive growth in more discretionary categories.

The Deloitte Consumer Tracker

Key indicatorsPrevious Latest

‑5% ‑8%

Overall consumer confidence (q/q)*

‑18% ‑18%

Confidence in level of disposable income (q/q)*

+15% +9%

Spending on essentials (y/y)*

‑5% ‑2%

Discretionary spending (y/y)*

+4.8% +2.5%

ONS retail sales value growth (exc. fuel) Dec‑14 (y/y)

+2% +0.5%

CPI inflation Dec‑14 (y/y)

AuthorsCéline FenechResearch ManagerConsumer Business020 7303 2064cfenech@deloitte.co.uk

Ben PerkinsHead of ResearchConsumer Business020 7307 2207beperkins@deloitte.co.uk

Aino PietikainenResearch Manager Consumer Business020 7007 4406aipietikainen@deloitte.co.uk

* Net balances

-18%-16%-14%-12%-10%-8%-6%-4%-2%0%

Q42014

Q32014

Q22014

Q12014

Q42013

Q32013

Q22013

Q12013

Q42012

Q32012

Q22012

Q12012

Q42011

Q32011

Chart 1. Spending in discretionary categories over the past three monthsNet % of UK consumers spending more by category

41216A Del_Con_Tr_QA.indd 1 23/01/2015 11:33

Deloitte Consumer Tracker Q4 2014

UK Real Estate Predictions: 2015

Recent research

UK Real Estate Predictions 2015This annual report reflects expert views from across Deloitte Real Estate in the UK. Last year we highlighted the rise of Taiwanese investors, the fall in high street vacancy rates, and the growing importance of urban logistics – just some of the predictions that came true. This year’s topics include overseas investors, bank lending and M&A prospects.

So, what will 2015 have in store for property in the UK?

Will MatthewsReal Estate Insight+44 (0)20 7303 4776wmatthews@deloitte.co.uk

UK Real Estate Predictions 2015

A Deloitte Insight report

Cost pressures to drive M&A in the constructionsector

Another year of strong performancein 2015

A year for M&A in the UK’slisted real estate sector

The UK in 2015: decent growth, low inflation…and political uncertainty

Serviced offices will go from strength-to-strength in 2015

Real estate remains key to the government’s deficit reduction plans

A period of major changes to

bank lending

starts in 2015

Wealthy overseas investors raise their stakes in UK real estate

2015: the year that data analyticstakes centre stage in environmentalcompliance

The battle for retail space

has shifted to

convenience formats

and is set to intensify in 2015

?

£ $€

£ $€

UK property handbook Quarter 1 2015 66

UK Real Estate Predictions 2015This annual report reflects expert views from across Deloitte Real Estate in the UK. Last year we highlighted the rise of Taiwanese investors, the fall in high street vacancy rates, and the growing importance of urban logistics – just some of the predictions that came true. This year’s topics include overseas investors, bank lending and M&A prospects.

So, what will 2015 have in store for property in the UK?

Will MatthewsReal Estate Insight+44 (0)20 7303 4776wmatthews@deloitte.co.uk

UK Real Estate Predictions 2015

A Deloitte Insight report

Cost pressures to drive M&A in the constructionsector

Another year of strong performancein 2015

A year for M&A in the UK’slisted real estate sector

The UK in 2015: decent growth, low inflation…and political uncertainty

Serviced offices will go from strength-to-strength in 2015

Real estate remains key to the government’s deficit reduction plans

A period of major changes to

bank lending

starts in 2015

Wealthy overseas investors raise their stakes in UK real estate

2015: the year that data analyticstakes centre stage in environmentalcompliance

The battle for retail space

has shifted to

convenience formats

and is set to intensify in 2015

?

£ $€

£ $€

UK property handbook Quarter 1 2015 66

| 7Property IQ Prospects remain positive

Key contacts

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Anthony DugganHead of Real Estate Strategyaduggan@deloitte.co.uk+44 (0)20 7303 3134

Julian StocksHead of UK Marketsjstocks@deloitte.co.uk+44 (0)20 7303 7210

Philip ParnellHead of Management and Valuationpparnell@deloitte.co.uk+44 (0)20 7303 3898

8 | Property IQ Prospects remain positive