Staying ahead of market conditions is vital

We take a look at the major trends influencing our occupational and investment markets. These can be highly diverse, ranging from the transformative effect of technology on retailing to the impact that milk prices have on our tenant farmers.


28 June 2016

1 New Burlington Place
Offshore wind turbine blades in transit
St James's Market
Banbury Gateway

Investment

The UK’s prominent role in international capital markets continues to have a significant impact on our business, particularly in central London. UK property is seen globally as a transparent, stable and liquid market and we’ve benefited from these characteristics in recent years. Whilst we don’t envisage any material changes in this regard in the near-term, the beneficial impact of low yields driving strong capital growth will inevitably slow.

Recent weaknesses in the global economy and a lack of domestic inflationary pressures have pushed out expectations for a rise in the UK base rate, and yields across world assets remain subdued. Nevertheless, 2015 was a solid year for investment in both London and regionally across the UK. CoStar data indicates it was the second strongest on record with £67.5 billion invested in commercial real estate in the UK, over 46% above the ten-year average. However with heightened pricing and market uncertainty, investment activity is more subdued as we move into 2016.

International capital has been key in driving demand in our core markets, making up 45% of this total. Whilst property allocations are increasing for many investors and others look to crystallise returns, we are mindful of the impact of wider geopolitical issues – such as the volatility in the oil price, fluctuating equity markets, the threat of an exit from the EU and instability in the Middle East – will have on investor intentions and market pricing.

Central London

Our commercial markets in central London continue to be characterised by a lack of supply and reasonable occupier demand, although the balance is certainly much more finely poised than in recent years. After some very strong years where a significant mismatch in dynamics has seen rental values rise strongly, we now expect markets to pause and rental growth to be more subdued.

Our prime retail destinations have benefited from London’s increasingly prominent role as a global shopping destination and a choice location for international retailers seeking to expand internationally. Whilst this continues to be the case, such expansionary brands are fewer and increasingly high occupational costs are seeing them become more selective and consider a broader range of locations. However, our prime locations and historically low levels of vacancy should ensure we continue to drive premium value from these assets going forward. Following our retail and restaurant successes at One New Burlington Place and St James’s Market, we have limited opportunities to deliver significantly more retail and restaurant space in the near term. Our priority remains to create world-class shopping and leisure destinations that people want to visit – achieving this through continued occupier management, rightsizing units, compelling marketing activities and crucial investment into the public realm. This is particularly important as the West End prepares for the delivery of Crossrail in 2018, which will bring a significant increase in visitors to our area.

People outside St James's Market

Our Central London Portfolio includes the whole of Regent Street and much of St James’s, and we are delivering a £1.5 billion investment and redevelopment plan.

Meanwhile, an incredibly strong business environment in London has driven robust rental growth across our large office portfolio in recent years; we have benefited from our diversity in this regard where we can cater to start-ups with just a few employees looking for flexible and accessible business space, through to international corporates seeking a global HQ. The strength of these sectors is likely to wane amidst continued global economic headwinds, in particular any shift in demand by banking & finance occupiers will have an impact on our high-value space. This is an area to which we are particularly attuned at the moment as we work to complete the office leasing of our major new developments, where we have already set new rental benchmarks in deals with world-class businesses. Combined with the potential for increased supply in response to current record-high rents, we anticipate the office market in the West End is fairly fully priced with opportunities for further growth firmly geared towards the lower range of rental values.

In central London, residential continues to be an attractive sector from which to extract capital to reinvest in our core commercial portfolio. After a number of years of consistently strong growth, prime residential values have slowed, or even plateaued, against a range of economic, political, regulatory and financial headwinds. However, given the unique and historic nature of many of our assets, demand is still there, albeit thinner and more selective than in the recent past. In particular, we anticipated the current weakness in the high-end new build residential sector and over the last year sought to de-risk our exposure to some projects through significant sales prior to completion.

Retail

Retail outside London is increasingly polarised, with strong schemes or locations retaining their appeal to a range of domestic (and increasingly international) occupiers, whilst certain formats and markets find themselves in structural decline. The pace of change in retailing over recent years has been unrelenting as technological advances have facilitated significant and sustained growth in online shopping. We anticipate this shift will continue and it will be the retailers most able to complement and capitalise on the multi-channel world that will succeed. We’re seeing this in our retail parks where click and collect facilities can be integrated to deliver in-store sales.

Banbury Gateway

We are one of the largest owners of major retail schemes outside the capital with 14 retail parks, three shopping centres and two leisure destinations.

Creating a diverse and appealing occupier mix and actively managing this to create dynamic destinations is more important than ever. The last year has seen continued retailer failure, although there have been fewer major casualties in the last year than previously. The recent high profile administration of BHS shows the challenge posed by retailers with very low margins. The margin challenge will be further exacerbated following the introduction of the National Living Wage, apprenticeship levy and the forthcoming ratings revaluation.

All of these factors result in a retail market where aggregate rental growth is very weak, and growth prospects looking forward are improving only marginally. However, there are pockets of growth on dynamic and actively managed schemes where vacancy remains very restricted; new development also remains very limited across both our key markets of retail parks and major shopping centres. As such we see our stock selection, active management and major development activity as key drivers of rental outperformance in a fairly low-growth retail environment.

Agriculture

For the first time in over a decade land values fell in agricultural markets throughout the UK, as investors and occupiers responded to uncertainty caused by continued pressure on commodity prices.

Research suggests farming profitability was down by as much as 20% in 2015 which prompted many farmers to capitalise on high land prices and dispose of their assets. Unsurprisingly, farmers also made up the smallest proportion of buyers in over a decade.

While average values for all land types throughout the UK were down in 2015, the regional dynamics show a more divergent picture. Prime arable in the east of England, a high value area with historically strong growth, has decreased in value in 2015 by over 10%, which primarily reflects an increased volume of transactions.
Conversely, grassland in the west of England which has historically been a low growth area, has increased in value this year by around 2%.

We still feel, however, that the underlying long-term characteristics of the agricultural capital markets remain strong, particularly as the sector continues to be attractive to non-farming or lifestyle buyers who remain motivated by a favourable tax regime, and pricing continues to be constrained by an imbalance between supply and demand.

Strategic land

Strategic land development

Through our in-house expertise we identify and acquire strategic land sites which are promoted through the planning process and sold to developers.

Over the course of the last year urban development land values increased by more than 5% and greenfield land values by nearly 3%. While the market responded positively overall to the continuity afforded by the outcome of the 2015 General Election, with an increase in planning permissions granted and an overall upturn in demand, there remains some uncertainty around local affordable housing provisions. This is likely to continue to have a dampening effect on values until greater clarity is provided by the Government.

Energy policy

Following the 2015 General Election, the new Government outlined a clear energy security agenda which included support for the deployment of up to a further 10 GW of offshore wind in the 2020s, subject to continued efforts on cost reduction within the sector. The second round of auctions for Contracts for Difference (CfD) is expected in 2016, and this will signal the start of investment for the post-2020 delivery period.

Infrastructure

Part of the Government’s strategy for energy security is to interconnect further the UK with neighbouring countries, and revised regulatory conditions have precipitated a strong market uptake in new interconnector projects coming forward. Separately, the Government is reviewing prospects for tidal range. Given the predictable nature of tides, projects that can harness this energy source have strong potential to contribute towards the UK’s future energy needs as well as contributing towards decarbonisation targets.