INVESTMENT BRIEFThe definitive guide to UK commercial property investment

Autumn 2019

geraldeve.com

-0.2%Q2 GDP

QUARTERLY GROWTH

£7.8BILLION

TRANSACTED IN Q2 (LOWEST SINCE

Q4 2012)

2.1%ALL PROPERTYTOTAL RETURN

IN 2019

£1.1BILLION

LARGEST OFFICE TRANSACTION

IN 2019

-5%SHOPPING

CENTRES ANNUAL RENTAL

GROWTH

6.3%MULTI-LET, ANNUAL

TOTAL RETURN2019-2021

68%QUARTERLY DECREASE

IN ALTERNATIVE INVESTMENT

IN Q2

2.9%AVERAGE ALL

PROPERTY TOTAL RETURN FORECAST

2019-2021

2 INVESTMENT BRIEF

• UK economic output contracted in Q2 2019 for the first time since Q4 2012. Similarly, investment in UK commercial property and the annual total return generated by those assets were also their weakest since 2012. A notable drop in portfolio sales contributed to a fall in the average property transaction size.

• Uncertainty surrounding Brexit is the major contributing and continuing factor, though commercial property is also late-cycle and this is set against a more general global economic slowdown.

• So far in 2019 there has been an increase in off-market and restricted marketing transactions to a bespoke target buyer list, with vendors reluctant to widely market their assets due to a lack of confidence.

• Subdued property investment volumes are expected while the Brexit impasse continues. There is domestic investment demand for UK commercial property, an attractiveness for overseas buyers and a well-functioning debt market. However, both buyers and vendors are, on the whole, still likely to wait it out until more clarity emerges.

• Commercial property annual total return is set to fall to 2.1% in 2019 and reach a low point of 2.0% in 2020. Income return is set to partially offset expected negative capital growth that will result from yield softening across most property segments.

• We have brought our forecast for retail units forward slightly. More deeply negative returns are expected for 2019 but with a similar correction overall. Retail is still anticipated to generate the lowest returns of any property sector over the next three years, with shopping centres particularly affected.

• Industrial is still forecast to outperform the other property sectors over the next three years, with only really the non-core properties expecting much outward yield shift. In particular there is still strength in multi-let, and London and the South East are forecast to outperform.

EXECUTIVE SUMMARY

EXECUTIVE SUMMARY 3

Sources: Property Data, Gerald Eve

AlternativeIndustrial

O�ceRetail

0

5

20

15

10

25

Q2

2019

Q1 2

019

Q4

2018

Q3

2018

Q2

2018

Q1 2

018

Q4

2017

Q3

2017

Q2

2017

Q1 2

017

Q4

2016

Q3

2016

Q2

2016

Q1 2

016

Q3

2015

Q2

2015

Q1 2

015

Q4

2014

Q3

2014

Q2

2014

Q1 2

014

Q4

2013

Q3

2013

Q2

2013

Q1 2

013

Q4

2012

Q3

2012

Q2

2012

Lowest quarter since Q2 2012

Q4

2015

£ billion

Quarterly investment into UK commercial property

4 INVESTMENT BRIEF

Quarterly GDP growth turned negative in Q2 for the first time since Q4 2012. The outturn was expected to be relatively muted as the large stockpiling in Q1, in anticipation of the first Brexit deadline, correspondingly fell out of the Q2 figures. However, an actual contraction in output took most commentators by surprise and revealed the soft underlying pace of growth in the domestic economy.

The same stockpiling factor, along with some car makers bringing their annual summer shutdowns forward to April, contributed to a 2.3% quarterly drop in manufacturing output, the biggest since 2009. Meanwhile, services sector output increased only 0.1%, while construction output dropped 1.3%.

On a more positive note, the combination of positive wage growth and moderate inflation improved households’ spending power, which was evident in a 0.5% rise in consumer spending. Government consumption also increased by 0.7%. However, the Q1 rise in business investment proved short-lived, with this component dropping by 0.5% in Q2.

Investors seemingly expect the economy to continue along a sluggish path. In recent weeks the 10-year bond yield fell to just under 0.5%, the lowest since records began in 1935. At a quarterly frequency up to Q2 2019, the fall in bond yield shows that the spread with the All Property equivalent yield was at its highest point since Q1 2017. This at least provides some leeway against upward pressure on property yields at this late-cycle point.

There are considerable uncertainties surrounding the current domestic political and economic outlook, but the base case is that some sort of orderly Brexit will ultimately be achieved. The forward-looking CIPS surveys suggest that the current economic weakness is set to persist, but a recession will be avoided.

Oxford Economics forecasts GDP growth of 1.3% in 2019 and 1.4% in 2020. The fallout from leaving the EU is likely to be felt in the manufacturing sector in 2020 and 2021 where Oxford Economics predicts employment will contract.

Though other major central banks have indicated they plan to loosen monetary policy, the Bank of England looks likely to keep base interest rates unchanged at 0.75% until well into next year, unless there is a no-deal Brexit or other downside risks to growth begin to play out.

UK ECONOMY

Source: Oxford Economics

-0.4

-0.2

0.6

0.4

0.2

0

0.8

1.0

1.2

1.4

Q2

2012

Q2

2019

Q4

2012

Q2

2013

Q4

2013

Q2

2014

Q4

2014

Q2

2015

Q4

2015

Q2

2016

Q4

2016

Q2

2017

Q4

2017

Q2

2018

Q4

2018

Q3

2012

Q1 2

013

Q3

2013

Q1 2

014

Q3

2014

Q1 2

015

Q3

2015

Q1 2

016

Q3

2016

Q1 2

017

Q3

2017

Q1 2

018

Q3

2018

Q1 2

019

%

UK quarterly GDP growth

Sources: Oxford Economics, MSCI, Gerald Eve

Spread of All Property yield over bonds (RHS)10-year bond yield

0

0.5

2.5

2.0

1.5

1.0

3.0

3.5

Q2

2012

Q2

2019

Q4

2012

Q2

2013

Q4

2013

Q2

2014

Q4

2014

Q2

2015

Q4

2015

Q2

2016

Q4

2016

Q2

2017

Q4

2017

Q2

2018

Q4

2018

Q3

2012

Q1 2

013

Q3

2013

Q1 2

014

Q3

2014

Q1 2

015

Q3

2015

Q1 2

016

Q3

2016

Q1 2

017

Q3

2017

Q1 2

018

Q3

2018

Q1 2

019

0

1

2

3

4

5

6

% %

10-year bond yields and spread over All Property

2014 2015 2016 2017 2018 2019 2020 2021

GDP growth 2.9 2.3 1.8 1.8 1.4 1.3 1.4 1.8

Consumer spending growth 2.1 2.7 3.2 2.2 1.8 1.7 1.5 1.9

Manufacturing employment growth 2.1 0.6 0.1 1.8 1.1 0.0 -1.5 -1.2

Services employment growth 3.2 1.8 1.7 0.5 0.6 1.3 0.8 1.0

10-year bond yield 1.8 2.0 1.3 1.3 1.3 0.8 1.1 1.5

RPI inflation 2.4 1.0 1.7 3.6 3.3 2.6 3.0 3.0

Key macroeconomic variables: history and forecastSource: Oxford Economics

UK ECONOMY 5

6 INVESTMENT BRIEF

Lowest investment volume and total return since 2012

Economic output contracted in Q2 2019 for the first time since Q4 2012. Similarly, investment in UK commercial property and the annual total return generated by those assets were also their weakest since 2012.

Investment volume has been subdued for the last two quarters, but the driver in Q2 was a steep drop-off in activity in alternatives, particularly hotels. Much of the current investment activity is off-market, to protect vendors from stigmatising their assets should they not sell in the present environment.

A generalised softening of yields, driven strongly by outward shifts in retail assets, increased the All Property negative annual yield impact in Q2. Annual rental growth was close to zero, so income return was the only positive contributor.

Uncertainty surrounding Brexit is the major contributing and continuing factor, though commercial property is late-cycle and this is set against a more general global economic slowdown. The political fallout has intensified recently with the appointment of Boris Johnson as British Prime Minister and his new, more hardline cabinet that has increased the perceived likelihood of a no-deal scenario.

Net flows out of open-ended property funds to increase in a no-deal scenario

In July, the Bank of England’s Financial Stability Report highlighted a potential risk to the commercial property market, suggesting that in a no-deal Brexit scenario, net outflows from open-ended property funds could be almost as large as after the EU referendum vote in 2016. Over the past six months, heightened uncertainty has seen average net outflows of around £100m, compared to average net inflows in 2018 of £20m. If a Brexit deal is secured, outflows are likely to reduce. However, in the event of a no-deal, heavier outflows than have been seen over the past six months can’t be ruled out.

EXECUTIVE SUMMARYALL PROPERTY

Sources: Property Data, Gerald Eve

AlternativeIndustrial

O�ceRetail

0

5

Q2

2012

20

15

10

25

Q2

2019

Q4

2012

Q2

2013

Q4

2013

Q2

2014

Q4

2014

Q2

2015

Q4

2015

Q2

2016

Q4

2016

Q2

2017

Q4

2017

Q2

2018

Q4

2018

Q3

2012

Q1 2

013

Q3

2013

Q1 2

014

Q3

2014

Q1 2

015

Q3

2015

Q1 2

016

Q3

2016

Q1 2

017

Q3

2017

Q1 2

018

Q3

2018

Q1 2

019

Lowest quarter since Q2 2012

£ billion

Quarterly investment into UK commercial property

Sources: MSCI, Gerald Eve

Income returnEquivalent yield impact

Rental growthTotal return

-5

5

Q2

2012

20

15

10

25

Q2

2019

Q4

2012

Q2

2013

Q4

2013

Q2

2014

Q4

2014

Q2

2015

Q4

2015

Q2

2016

Q4

2016

Q2

2017

Q4

2017

Q2

2018

Q4

2018

Q3

2012

Q1 2

013

Q3

2013

Q1 2

014

Q3

2014

Q1 2

015

Q3

2015

Q1 2

016

Q3

2016

Q1 2

017

Q3

2017

Q1 2

018

Q3

2018

Q1 2

019

0

2.7% total

return

3.1% total

return

%

Annual total return and components

Yields and exchange rates make the UK more attractive to overseas investors

Overseas investment demand is somewhat cautious but has been broadly maintained so far over 2019. A comparative positive for UK commercial property internationally is that exchange rates against the US dollar and the euro are historically low and, since the 2016 EU referendum, UK commercial property yields are relatively higher than in counterpart property markets abroad where borrowing is relatively cheaper.

ALL PROPERTY 7

Sources: Investor Association, Capital Economics

Monthly total6 month average

-1200

-600

2013

300

0

-300

600

2019 2015 2017 2014 2016 2018

-900

£ million per month

EU referendum

Net flows into open-ended property fundsSources: MSCI, Gerald Eve

UKUSA

Pan-AsianFrance

Germany

4.0

6.5

Q1 2

019

Q3

2012

Q1 2

013

Q3

2013

Q1 2

014

Q3

2014

Q1 2

015

Q3

2015

Q1 2

016

Q3

2016

Q1 2

017

Q3

2017

Q1 2

018

Q3

2018

4.5

Q1 2

011

Q3

2011

Q1 2

012

6.0

5.0

5.5

%

Net initial yields by country

Sources: Oxford Economics, Gerald Eve

$US per £Euros per £

1.0

1.1

1.4

1.3

1.2

1.8

Q2

2019

Q3

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q3

2018

Q1 2

014

Q1 2

015

Q2

2015

1.7

1.5

1.6Q

1 201

9

Q2

2014

Q3

2014

Q4

2014

Q4

2015

Q2

2018

Q4

2018

Currency per £

UK exchange rates, 2014-2019

8 INVESTMENT BRIEF

Subdued investment activity and an increase in off-market transactions

Overall office investment ticked up in Q2, but this was the result of an exceptional £1.1bn sale to Citigroup, which purchased its headquarters at 25 Canada Square in Canary Wharf. Underlying investment activity remains subdued and average per-quarter investment so far in 2019 of £3.1bn is 46% down on the per-quarter average over 2016-18.

So far in 2019, there has been a notable increase in off-market and restricted marketing transactions to a bespoke buyer target list, with vendors reluctant to actively market their assets due to a lack of confidence.

Shortage of available investment stock curtailing activity in London

The recent hesitancy in the London investment market is largely due to lack of vendors, and as a result there was little investment stock available to buy in the first half of 2019. The transactions that did take place were mostly down to investors under some pressure to sell.

However, the occupational market remains strong with high demand for new space. This combined with a lack of good quality grade A available space will lead to continued rental growth across the West End, Midtown, and the City. However, negative yield movements over the forecast period in Midtown and the City, will result in a slight decline in capital values in 2019 and 2020.

Vendors in the South East actively targeting local authorities and institutions

Following a slow start to the year, frustrated investors selectively returned to the South East office market for the right opportunities. As a result, the transaction volume increased but still remained 28% below the five-year average.

Vendors have targeted local authorities and institutions, seeking premium pricing through exclusive campaigns. Whilst completion timescales have become prolonged, there has also been a contraction in the number of underbidders compared to those on similar assets a year ago, with an ongoing standoff between vendors and purchasers on pricing.

Investors will take comfort in the robust nature of the South East occupational market as income continues to be a key driver in investment performance at this stage of the cycle. The underlying fundamentals in the South East include; acute pressures on availability, increasing take up of grade A space, scarcity of speculative development, strong demographic compositions and improving infrastructure connections, which will likely translate into continued rental growth.

EXECUTIVE SUMMARYOFFICES

Sources: Property Data, Gerald Eve

LondonSouth East

Rest of the UK

0

1

4

3

2

8

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q4

2015

Q1 2

016

Q2

2016

7

5

6

Q1 2

019

£ billion

UK o�ce transaction volumes

UK office capital value growth turned negative in Q2, driving lowest investment return since 2016

The drop in investment activity has negatively impacted performance and in Q2 2019 the average office capital value fell by 0.1% on the quarter. This was driven by some yield softening, with quarterly yield impact recorded at -0.2%. Overall the quarterly total return for the sector was 0.9%, its lowest since the referendum in 2016.

In the last 12 months offices outside of the South East have been the most robust, recording an annual total return of 6.5% in Q2, compared with 5.2% in the South East, and only 4.4% in central London. Yield compression has generally been stronger in the regional cities, reflected by an annual yield impact of 2.3%. Rental growth here has also been relatively strong, rising by 1.2% year on year, compared with central London (1.1%), and the South East (0.4%).

Overall the office market is forecast to achieve an annual total return of 5.1% in 2019, largely driven by income return. We expect to see a slightly weaker performance in 2020, with further yield softening forecast. However, the lack of available space across most core office markets will lead to further positive rental growth, which will offset some of the negative impact on capital values by outward yield movements.

OFFICES 9

Sources: MSCI, Gerald Eve

Central LondonInner South East & EasternRest of the UK

0

2

10

8

6

4

12

14

16

18

20

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q4

2015

Q1 2

016

Q2

2016

Q1 2

019

%

Rolling annual o�ce total return, by region

Forecast

Sources: MSCI, Gerald Eve

Income returnRental growth

Yield impact

-4

2

0

-2

10

8

4

6

2017 2018 2019 2020 2021

%

UK office, total return and components

Total return

Sources: MSCI, Gerald Eve

Equivalent yield impactMarket rental value growthCapital growth

-4

-3

0

-1

-2

4

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q4

2015

Q1 2

016

Q2

2016

3

1

2

Q1 2

019

%

Quarterly capital growth drivers

10 INVESTMENT BRIEF

EXECUTIVE SUMMARYRETAIL

Investor confidence in the occupier side of retail continues to be low while the sector is mired in the current political uncertainties and reduced consumer spending. This has been compounded by the long-term structural changes that include the rising retailer cost base and ongoing significant loss of market share to online competitors.

There were 21 retail failures in 2019 before May, resulting in 727 store closures. This represents an acceleration on 2018 when 43 companies went bust, at a cost of 2,594 stores, which was itself an acceleration on 2017. The impact of retailer failures goes beyond the properties that are directly affected because the value of a lease to any connected or related retailer that is considered to be a likely candidate for future insolvency is similarly diminished. Overall investor appetite for retail assets has therefore deteriorated substantially.

In general, funds remain overweight in retail and are net sellers as they seek to streamline portfolios and reduce their exposure to the sector.

On a small positive note, however, the retail investment transaction total increased in Q2 2019 for the first time in a year. This was driven predominantly by increased investment into supermarkets.

Long-let supermarkets located in affluent areas with strong underlying alternative use potential are still relatively in demand. Most notably, J Sainsbury sold its Superstores Portfolio in Q2 to US investor Realty Income for £429m.

Supermarkets recorded a positive annual total return of 5.5% in June 2019. Whilst the segment has also seen some yield softening and negative annual rental growth of 1.2%, it was offset by income return.

Shopping centre investment also increased in Q2 with a number of investors targeting the segment which they feel they can purchase at a discount, buying from institutions who are nervous of the market and want to sell-down assets.

Retail rental growth has turned increasingly negative and has fallen a cumulative 4.1% since Q1 2018. The fall in rent is symptomatic of the long-term structural shift for the sector and all segments have been affected, with shopping centres performing particularly poorly.

Commensurately retail yields have moved out significantly and have been the highest-yielding property sector for the last two quarters. This has generated negative yield impact which, when added to the fall in rents, has resulted in a significant drop in capital value and a notable underperformance of retail compared with the other property sectors.

Sources: Property Data, Gerald Eve

Retail warehouseShopping centre

Supermarket Unit shops

0

0.5

2.0

1.5

1.0

4.0

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q4

2015

Q1 2

016

Q2

2016

3.5

2.5

3.0

Q1 2

019

£ billion

Investment volumes by retail segment

Sources: MSCI, Gerald Eve

All retailShopping centres

High streetRetail warehouse

-6

4

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

-3

Q2

2014

Q1 2

015

Q2

2015

3

-2

-1

2

1

0

-4

-5

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

%

Retail annual rental growth, by subsector

RETAIL 11

Shopping centres have been the worst performing segment, with a consistent fall in capital values dating back to March 2017, cumulating in an 18.3% loss of value. There is also a lack of automatic planning change of use to residential for vacant shopping centres, as sometimes witnessed with offices and industrial, which sets a particular challenge to the future of these assets.

Retail parks continue to see sharp drops in values, with only those parks which are either better quality assets, or closer to London, being more protected against capital falls. This protection was evidenced by CCLA’s acquisition of Pavilion Retail Park in Brighton for £32m, reflecting a net initial yield of 5.5%, and CBREGI’s acquisition of Bell Green Retail Park in Sydenham for £50m, reflecting a net initial yield of 5.9%.

Looking forward, we expect 2019 to be the low point for retail total returns, at -6.5%. We still expect rental growth and yield impact to be moderately negative in 2021, but income return should bring total return back into positive figures before the sector stabilises in 2022.

Sources: MSCI, Gerald Eve

All propertyAll o�ce

All retailAll industrial

5.0

8.0

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q2

2014

Q1 2

015

Q2

2015

7.5

5.5

7.0

6.5

6.0

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

%

Commercial property equivalent yields, by sector

Sources: MSCI, Gerald Eve

Yield impactRental growth

Income return

-15

0

-5

-10

10

5

2016 2018 2019 2020 20212017

Forecast

%

UK Retail, total return and components

Total returnSources: MSCI, Gerald Eve

High streetShopping centresRetail warehouses

80

110

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q2

2014

Q1 2

015

Q2

2015

105

85

100

95

90

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

Index, Sept 2016 = 100

Retail subsector capital values

Industrial investment falls for third consecutive quarter

Investment into industrial assets fell further in Q2 2019, in line with the ongoing trend observed across all commercial property segments. The total investment in Q2 was around £1bn, which is just over half the amount invested in Q1 and the lowest industrial volume since Q3 2016.

The geographies where industrial investment volumes have held up over recent quarters are in the East Midlands & East of England and London. These areas accounted for almost £560m of transactions in Q2, which was around half of the total UK volume. Notably, Sports Direct sold its Brook Park distribution warehouse in the East Midlands to Malaysian investors for £120m. In the Greater London area, GlaxoSmithKline sold its Stockley Park distribution warehouse in Uxbridge to Prologis for £57m.

Drop in portfolio deals also contributed to a fall in average deal size

Lack of portfolio sales and investment in the South East, along with most other UK regions, were the drivers of the broader downward trend. Portfolio sales were a strong feature of 2018, with 185 transactions accounting for almost £14bn, including the £1.5bn sale of Network Rail’s Arches portfolio to Blackstone and Telereal Trillium. In Q2 there were only five such deals, totaling £177m. The most significant deal by far was the sale of the R32 Portfolio to M7 Real Estate for £100m.

The drop in portfolio sales also contributed to the fall in average deal size to £8.3m in Q2 – the lowest we have on recent record.

Demand wanes for core-plus investments

The increased sense of risk and uncertainty, especially over the medium term, means that there is currently little investment demand for mid-length income of 5- 10 years. Assets with 15 years or more of income are still sought after as relatively low-risk options. Equally, short income assets that present asset management opportunities to generate improved returns at this late point in the property cycle are still in demand.

Much of the current industrial investment activity is off-market, to protect vendors from stigmatising their assets should they not sell in the present environment.

12 INVESTMENT BRIEF

Sources: Property Data, Gerald Eve

Average lot size (LHS)Transactions (RHS)

0

5

20

15

10

25

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q2

2016

Q1 2

019

0

50

100

150

200

250

No. transactions£ million

Industrial investment by quarter

INDUSTRIAL

Sources: Property Data, Gerald Eve

East Midlands and East of EnglandLondon

Rest of the UKSouth East

Portfolios

0

0.5

2.0

1.5

1.0

5.0

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q2

2016

3.5

2.5

3.0

Q1 2

019

4.0

4.5

£ billion

Investment into UK industrial – Regional

There has not been a perceived increase in forced sellers. However, some retail funds have sought to sell some industrial assets to free up cash for a potential increase in redemptions. The M&G Property Portfolio is notable in having recently suspended activity for up to six months to enable an orderly sell-down.

More broadly though, it is unlikely that there will be a run on retail funds, and a majority are already underweight on industrial. Industrial is a more liquid asset than all retail segments but, if funds come under more pressure, selling more industrial will undermine their long-term viability. Thus any future potential pressure from further redemptions would mean funds would be more likely to suspend the fund rather than release more industrial into the market, as with M&G.

Returns down, but industrial still outperforming other property segments

Despite low investment volumes, sentiment for industrial is still comparatively good in the context of the other UK property segments. This is borne out in the ongoing superior total returns and rental growth achieved over recent years.

Industrial returns have fallen sharply from their peak in mid-2018 now that yields are no longer dropping rapidly, and the commensurate positive yield impact has fallen out of the figures. In line with investment demand, yields on prime assets with long income have held stable. Equally, pricing on shorter income and lower quality assets have held relatively firm. Good secondary assets between these two extremes have fared less well, with an outward yield shift of around 50-75 basis points over 2019.

Industrial annual rental growth, notably for multi-let, is also easing from a relatively high level. However, despite the sharp fall in industrial total return, this is set to stabilise at a lower level of around 5.5% over the medium term. Some small negative yield impact over 2020/21 is set to reduce returns to just below 5%, but will remain ahead of the other property segments.

INDUSTRIAL 13

Sources: MSCI, Gerald Eve

RetailO�ce

Multi-letDistribution warehouse

-10

25

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q2

2014

Q1 2

015

Q2

2015

20

-5

15

10

5

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

0

%

Annual total return by property segment

Sources: MSCI, Gerald Eve

RetailO�ce

Multi-letDistribution warehouse

5.0

8.0

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q2

2014

Q1 2

015

Q2

2015

7.5

5.5

7.0

6.5

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

6.0

%

Equivalent yields by property segment

Sources: MSCI, Gerald Eve

RetailO�ce

Multi-letDistribution warehouse

-4

10

Q2

2019

Q3

2015

Q4

2015

Q1 2

016

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q2

2014

Q1 2

015

Q2

2015

8

-2

6

4

2

Q3

2014

Q4

2014

Q4

2018

Q1 2

019

0

%

Annual rental growth by property segment

14 INVESTMENT BRIEF

Quarterly investment volume falls significantly

Investment transactions into alternatives dropped off significantly in Q2 to £1.5bn after holding up relatively well up until that point.

Investment activity in hotels in particular fell very sharply in Q2. In general though, an increasing number of hotel purchases have transacted by way of forward-funding or forward-commitment arrangements. A lack of suitable up-and-built stock means this the only plausible option for investors to acquire within the market. One notable example is KFIM’s forward funding acquisition of the mixed-use Travelodge hotel and restaurant scheme in St Albans (advised by Gerald Eve) in April 2019 for £24m, reflecting a net initial yield of 4.4%.

Investment in the leisure market totalled £230m in Q2 2019, which was largely driven by a flurry of activity surrounding the pub sector. Notable transactions include EI Group’s sale of Project Tavern to Davison Kempner Capital and British Land’s sale of its entire pub portfolio to Aprirose.

Over £300m of student accommodation transacted in Q2 and overall investment fundamentals for the sector remain largely positive, with international applicants driving an overall increase in student numbers in recent years. However, a declining 18-20 year old population in the UK, combined with increased risks to university finances provide medium-term concerns for the sector.

Investment stock in healthcare remains low and, whilst this is having a positive impact on pricing with prime yields being held down, there are few options for investors. In Q2 2019, only £213m transacted, 46% less than Q1 and 74% less than Q4 2018. A notable transaction was Blackrock’s off-market acquisition of the Montefiore Hospital, Hove (advised by Gerald Eve) in March 2019 for £39m, reflecting a net initial yield of 4.6%.

Relatively strong but diminishing returns from Alternatives

Across the alternative property market, occupier trends remain positive and, in most cases, continue to benefit from long-term structural growth. Underlying investment demand is also relatively robust compared to the other property segments, with investors attracted to the defensive rental profiles which are often index-linked or profit-related.

Annual total returns from alternatives are passed their early 2018 peak as rental growth has slowed and yields have drifted slightly higher, especially in the leisure and hotels segments. Nevertheless, alternative assets recorded an annual total return of 6.5% in Q2 2019, with only industrial generating a stronger return.

Prime yields across the sector have remained relatively resistant to upward pressures so far, but there are signs that buyers are becoming more particular amid Brexit fears, and there is a growing trend of portfolio break-ups as investors seek to spread their covenant and sector risk.

ALTERNATIVES

Sources: Property Date, Gerald Eve

HealthcareHotel

ResidentialStudent accomodation

Leisure

0

1

7

Q2

2019

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q4

2015

4

2

3

Q1 2

019

5

6

Q2

2016

Q1 2

016

£ billion

Transaction volumes by sector

Sources: MSCI, Gerald Eve

AllHealthcare

LeisureResidential

Hotel

4

16

Q2

2019

Q2

2016

Q3

2016

Q4

2016

Q1 2

017

Q2

2017

Q3

2017

Q4

2017

Q1 2

018

Q2

2018

Q3

2018

Q4

2018

Q1 2

019

8

Q3

2015

Q4

2015

Q1 2

016

14

10

12

6

%

Average annual total return by segment

ALTERNATIVES 15

High returns for primary healthcare

The healthcare market continues to be in high demand, with the buyer pool widening in the light of its long-income nature, as well as the growing investor understanding of the sector. The healthcare sector annual total return was 8.2% in Q2 2019, the highest return of the alternative assets.

Primary healthcare should see an improvement in rental growth in the second half of 2019 as RPI-linked leases steadily increase and open market rents start to see upward pressure. This growth, allied with low-risk tenants and low asset value volatility, has made GP surgeries an attractive investment.

Over the long term, larger fit-for-purpose buildings will be better equipped to accommodate the rising volume and broadening scope of services offered through primary care centres. These large modern GP practices provide greater patient, organisational and cost benefits to the healthcare system and, consequently, could benefit from strong cross-party support for private investment.

Alternative assets still attractive after Brexit

The structural trends which underpin many of the alternative markets compare relatively favourably against the other property segments, and this is likely to continue after any kind of Brexit that is ultimately delivered. Over the long term, these assets could outperform other property asset classes, given their superior cross-cycle rental growth, higher income and lower capital value volatility.

Subdued investment volumes are expected while the Brexit impasse continues. Not only is there significant investor uncertainty over the outcome of the new 31st October deadline, but there also remains uncertainty over whether this date will simply be extended further. There continues to be domestic investment demand, an attractiveness for overseas buyers and a well-functioning debt market. However, bother buyers and vendors are, on the whole, still likely to wait it out until more clarity emerges.

Commercial property annual total return is set to fall to 2.1% in 2019 and reach a low point of 2.0% in 2020. Income return is set to partially offset expected negative capital growth that will result from yield softening across most property segments.

Outward yield shift for retail segments delivered more negative than expected returns in the first half of 2019, so we have brought our forecast for the sector forward slightly. More deeply negative returns are expected for 2019 but with a similar correction overall. Retail is still anticipated to generate the lowest returns of any property sector over the next three years, with shopping centres particularly affected.

The easing of the very significant positive returns from the industrial segments is expected to continue over 2019. However, industrial is still forecast to outperform over the next three years, with only really the non-core properties expecting much outward yield shift. In particular there is still strength in multi-let, where assets still have pent up rental growth to be realised, set against an exceptionally supply-constrained backdrop.

Offices are set to fare better than retail, though some of the more cyclical central London markets will pull down the overall office average in the short term. The South East office occupational markets should remain generally resilient, especially with the further erosion of supply through ongoing residential permitted development. This combined with the higher income return component for the South East puts it on track to outperform the City office markets over 2019-21.

OUTLOOK

16 INVESTMENT BRIEF

OUTLOOK 17

Sources: MSCI, Gerald Eve

-3

-1

3

2

1

0

4

5

6

7

All m

ulti-

let

All p

rope

rty

Wes

t End

o�

ce

Sout

h Ea

st o

�ce

City

o�

ce

Reta

il w

areh

ouse

All r

etai

l

Rest

of t

he U

K o�

ce

All o

�ce

All i

ndus

tria

l

Dist

ribut

ion

war

ehou

ses

Shop

ping

cen

tres

High

stre

et

-2

%

Total return, average annual 2019-21Sources: MSCI, Gerald Eve

Income returnYield impact

Rental growth

-4

2

0

-2

12

4

2016 2018 2019 2020 20212017

Forecast10

6

8

%

All property total return and components

Total return

Total return

Income return

Yield impact

Rental growth

All Property 2.9% 4.5% -2.1% 0.5%

Retail -2.3% 5.7% -5.1% -2.6%

High Street -2.4% 4.5% -4.4% -2.3%

Shopping Centres -1.8% 6.0% -4.5% -3.1%

Retail Warhouse -0.5% 6.4% -4.1% -2.5%

Office 5.3% 4.2% -0.7% 1.7%

City Office 4.0% 3.9% -1.0% 1.1%

West End Office 5.5% 3.6% -0.8% 2.7%

South East Office 5.0% 5.2% -1.8% 1.7%

Rest of UK Office 6.0% 4.8% -0.1% 1.2%

Industrial 4.9% 3.6% -1.7% 3.1%

Multi-Let 6.3% 3.8% -1.3% 3.7%

Distribution Warehouse 3.6% 5.0% -2.9% 1.6%

Forecasts by main property segment: annual average total return and components (2019-2021)Sources: Gerald Eve, MSCI

For more information on individual sectors, please see the following publications:

Prime Logistics BulletinQ2 2019

London MarketsSummer 2019

Multi-LetSummer 2019

PRIME LOGISTICSThe definitive guide to the UK’s distribution property market

Q2 2019 Bulletin

1 2 3 4 5 6

geraldeve.com

LONDON MARKETSThe definitive guide to

Summer 2019

geraldeve.com

MULTI-LETThe definitive guide to the UK’smulti-let industrial property market

Summer 2019

geraldeve.com

18 INVESTMENT BRIEF

Healthcare

Richard Moir PartnerTel. +44 (0)20 7333 6281Mobile +44 (0)7771 812249rmoir@geraldeve.com

Regional Investment

Callum Robertson PartnerTel. +44 (0)16 1259 0480Mobile +44 (0)7810 655791crobertson@geraldeve.com

South East Offices

Guy Freeman PartnerTel. +44 (0)20 3486 3471Mobile +44 (0)7796 813141gfreeman@geraldeve.com

Leo Zielinski PartnerTel. +44 (0)20 3486 3468 Mobile +44 (0)7980 809031lzielinski@geraldeve.com

Portfolios

Alternatives/Long income

Richard Lines PartnerTel. +44 (0)20 7333 6274Mobile +44 (0)7825 721289rlines@geraldeve.com

Lloyd Davies PartnerTel. +44 (0)20 7333 6242Mobile +44 (0)7767 311254ldavies@geraldeve.com

London offices

John Rodgers PartnerTel. +44 (0)20 3486 3467Mobile +44 (0)7810 307422jrodgers@geraldeve.com

UK Capital Markets

Nick Ogden PartnerTel. +44 (0)20 3486 3469Mobile +44 (0)7825 106681nogden@geraldeve.com

Industrial & Logistics

Valuations

Michael Riordan PartnerTel. +44 (0)20 7653 6828Mobile +44 (0)7796 611127mriordan@geraldeve.com

Leisure

Charles Wilford PartnerTel. +44 (0)20 7333 6215Mobile +44 (0)7774 834113cwilford@geraldeve.com

Leisure

Daniel Anning PartnerTel. +44 (0)20 7333 6374Mobile +44 (0)7776 161821danning@geraldeve.com

Will Kirkpatrick PartnerTel. +44 (0)20 7333 6228Mobile +44 (0)7836 287983wkirkpatrick@geraldeve.com

Hotels

Research

Alex Dunn AssociateTel. +44 (0)20 3486 3495Mobile +44 (0)7917 587230adunn@geraldeve.com

Research

Ben Clarke Senior AssociateTel. +44 (0)20 7333 6288bclarke@geraldeve.com

Research

Steve Sharman PartnerTel. +44 (0)20 7333 6271Mobile +44 (0)7508 008118ssharman@geraldeve.com

CONTACTS

CONTACTS 19

London (West End) 72 Welbeck Street London W1G 0AY Tel. +44 (0)20 7493 3338

London (City)46 Bow Lane London EC4M 9DL Tel. +44 (0)20 7489 8900

Birmingham45 Church Street Birmingham B3 2RT Tel. +44 (0)121 616 4800

Cardiff32 Windsor Place Cardiff CF10 3BZ Tel. +44 (0)29 2038 8044

Glasgow140 West George Street Glasgow G2 2HG Tel. +44 (0)141 221 6397

Leeds1 York Place Leeds LS1 2DR Tel. +44 (0)113 204 8419

ManchesterNo1 Marsden Street Manchester M2 1HW Tel. +44 (0)161 259 0450

Milton KeynesAvebury House 201-249 Avebury Boulevard Milton Keynes MK9 1AU Tel. +44 (0)1908 685950

West Malling35 Kings Hill Avenue West Malling Kent ME19 4DN Tel. +44 (0)1732 229420

Disclaimer & copyrightThis brochure is a short summary andis not intended to be definitive advice.No responsibility can be accepted forloss or damage caused by reliance on it.

© All rights reserved

The reproduction of the whole or partof this publication is strictly prohibitedwithout permission from Gerald Eve LLP

09/19

OFFICES