UK Capital Markets · listed vehicles. Leases are landlord-favourable and longer than other major markets, reducing the risk and increasing the reliability of income streams. International

UK Capital MarketsReview and Outlook

H1 2019

H1 2019 UK Capital Markets

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H1 2019 | Direct Real Estate Investment H1 2019 Review

Weaker volumes in H1 as politics dampens demandOngoing uncertainty around Brexit dampened UK commercial real estate transactional activity in Q2, with investment volumes slowing to £8.9bn, bringing the H1 total to £21.5bn. This represents a 22% decline on H1 2018 and was the slowest first half of the year since 2013, following a strong five years of investment volumes.

Increased risk-aversion among investors resulting from the chaotic political landscape has certainly been a factor in these lower levels of transactional activity. In addition, the market has reached a mature stage in the current cycle which has also impacted investment. Lower levels of liquidity in the market are causing the ‘bid-ask’ spread to widen, slowing transactional activity further.

Living continues to surge, but traditional sectors are all slowingWithin the sectors, the office investment market slowed the most, with transaction levels falling by 43% compared to the first half of last year, followed by hotels (-26%) and industrial (-15%). While the retail investment market only declined by 10% in H1, this is already coming off a lower base following previous declines in 2017 and 2018. The challenges facing the retail sector are well documented, but supermarkets remain sought after, highlighted by the £429m Sainsbury’s portfolio acquisition by US-based Realty Income Corporation in their first cross-border purchase, in what was the largest UK transaction in the second quarter of 2019.

Despite the reduction in activity elsewhere, the Living sector continued to grow in the first half of this year, recording a 31% rise in transactional volumes. The sector, which comprises build-to-rent residential, student housing, senior living and elderly care, saw £5.3bn invested across H1, with significant demographic and structural changes underpinning demand, and supporting a flurry of transactional activity in this space.

Market fundamentals remain strong in core sectorsA large factor in the fall in office investment volumes was the Central London office market which saw only £4.5bn traded, the lowest in 10 years, with investors acutely aware that this highly globalised market is the most exposed to any adverse impact from a ‘no-deal’ Brexit.

That said, smaller lot sizes, especially in the value-add/opportunistic space, remain in high demand as investors target development opportunities and the likely supply gap in 2020 – 2022. Occupational fundamentals remain highly supportive of sustained investment, with above average leasing volumes, low vacancy rates and a constrained development pipeline, resulting in prime rental growth in both the City and the West End in Q2. Consequently, we expect investment activity to pick up again quickly once the political situation becomes clearer.

While we have seen a slowdown in the industrial investment market after a surge in activity over the last two to three years, volumes remain broadly in line with the five-year average. The industrial sector is still performing well overall, with rental growth forecasts remaining buoyant. The sector has seen significant yield compression in recent years and is now among the most expensive, with the JLL prime industrial yield currently standing at just 4%.

Domestic investors account for an increased share as cross-border activity briefly dipsDomestic investors accounted for 50% of all purchases in H1, with the Americas region accounting for 20%, the largest overseas buyer group. We believe the marked slowdown in cross-border investment is merely a pause, as the wall of international capital continues to wait on the side lines. Indeed, with the US Fed, ECB and Bank of Japan all signalling further easing in monetary policy to come, we expect a further reduction in long term yields.

The UK remains a highly attractive destination for investment. It is the second largest market globally after the USA, and London has been the world’s most traded city for 7 of the past 10 years. It also sees consistently the largest cross-border flows of any market globally. According to JLL’s Global Real Estate Transparency Index, the UK is the world’s most transparent market, with high levels of liquidity, strong legal and regulatory frameworks and robust governance of listed vehicles. Leases are landlord-favourable and longer than other major markets, reducing the risk and increasing the reliability of income streams. International investors also benefit from attractive currency conditions, with Sterling (£) trading at a discount of 15 – 20% against most major global currencies since the EU referendum. Prime office yields also remain significantly higher than comparable European and Global cities.

£1.2bnScotland15%

£0.2bnNorth East38%

£0.6bnYorkshire & Humber33%

£0.6bnEast of England3%

£1.5bnSouth East30%

£0.7bnEast Midlands

63%

£1.3bnNorth West

20%

£9.9bnGreater London

18%

£0.2bnWales51%

£0.1bnWest Midlands

3%

£6.8bnCentral London

34%

* excludes corporate finance and development deals** Living: PRS, Student Housing, Healthcare*** Other: Automotive, Data Centres, Self Storage

£0.4bnSouth West50%

Fund Managers

Private Investors

Property Companies

Institutional Capital

REITs / Listed RE Companies

Corporate

Private Equity

Government

Purchaser type by volume 2019 H1Source: JLL, 2019

Domestic 1.6bnOverseas 0.7bn








Europe ex. UK8%

UK50%

Middle East & Africa5%

Global9%

Americas20%

Domestic andinternational

investors 2019 H1Source: JLL, 2019

Asia-Pacific5%

Portfolios£4.2bn27% Total UK

investment volumes£21.5bn*

22% Y-ON-Y

Product typeby volumes % of

total volumes10-year average

Source: JLL, 2019

O�ice34% | 45%

Mixed1% | 4%

Living**25% | 9%

Other***1% | 2%

Hotels12% | 9%

Industrial13% | 11%

Retail14% | 21%


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JLL Real Estate Investor

Confidence SurveyHow would the impacts of a No Deal

scenario affect your business?Where are you likely to be on the risk curve?

4%

17%

50%

6%

23%

■ Impacts would be positive■ Impacts would be neutral■ Impacts would be negative but not be as severe as some fear■ Impacts would be severely negative but short-term■ Impacts would be severely negative and long-term

■ Core ■ Core +■ Value add ■ Oportunistic

17%

29% 31%

23%

Over the next 12 months, how will UK commercial property market returns (income + capital) compare

to the last 12 months?

How do you currently view the retail sector?

46%

31%

19%

4%

■ Major risk – will not invest■ Moderate risk – would only consider investing very selectively■ Moderate opportunity – will likely invest selectively■ Significant opportunity – will actively seek investment opportunities

13%

62%

13%

12%

0%

■ A lot lower ■ Slightly lower■ Unchanged ■ Slightly higher■ A lot higher

In which living sector are you looking to commit the most capital over the next 12 months?

Over the next 12 months do you plan...

■ None ■ Build to rent residential■ Senior Living ■ Student Housing■ Healthcare ■ All

31%

10%6% 4%

44%

6% 73%

17%

10%

■ To be a net investor■ No activity planned■ To be a net divestor

Which of the following political events would be best for your company?

14%General election

36%No Deal

Brexit

46%Second

referendum

4%Further Brexit

Delay


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Outlook 2019 H2

Brexit will continue to polarise opinionsPolitics has been at the forefront of investors’ minds through the first half of the year, as the debate rages on over the UK’s departure from the European Union. Positions on this issue have now hardened to the point where compromise seems very unlikely, but the options remain the same as they have always been as we approach our third ‘deadline’ of the 31st October. Oxford Economics’ current base case is for further delay, but the rhetoric from the new Prime Minister suggests a hard Brexit looks more likely.

The polarisation of views on Brexit is highlighted by the results of our Investor Confidence Survey. The largest group of respondents (46%) feel that a second referendum would be best for their company, likely indicating strong support to remain in the EU. However, the second largest group (36%) favour an extreme ‘no-deal’ exit. Interestingly, of those preferring no-deal, 83% believe that this scenario will have a negative impact on their business, including 28% who believe the impact will be severely negative. Among all respondents, 90% believe no-deal would have a negative impact, including 40% who believe these impacts will be severe.

Overseas buyers are waiting in the wingsWhile the political situation has resulted in heightened caution among investors, we expect a renewed influx of international capital when the situation has stabilized. South Korean buyers, the largest overseas group in in 2018, have been largely absent from London so far this year as hedged cash-on-cash returns have dipped below their required thresholds. However, we have seen selective acquisitions in other markets where these financial metrics have been met, notably Edinburgh, and we expect this group to return strongly when pricing and financing allows.

Hong Kong investors acquired at record levels in 2017, and the recent civil unrest may prompt a further wave of capital flight towards safe-haven markets, supported by improving currency conditions that are particularly salient to this investor group. There is also likely to be increased activity among Private Equity buyers, who have continued to raise capital aggressively and target real estate. They are looking to take advantage of widening spreads, strong property market fundamentals and the current low cost of debt.

Activity expected to continue across the risk curveDespite the weak sentiment in the market at present, it is encouraging to see the majority of respondents to our Investor Confidence Survey (73%) saying they still planned to be net investors over the next 12 months. There is no clear pattern among these buyers as to their risk appetite. Anecdotal evidence suggests strategies are polarised, either focussed on core or prime assets where the risk is most limited, or a more risk-on approach based around development opportunities. However, this is not borne out by the results of our survey. While there was a spread of responses, the majority (60%) were in the middle of the spectrum, a focus on Core+ and Value Add opportunities.

Retail remains a risk but will offer opportunitiesThe retail sector continues to face huge structural challenges, and investment has been lower in recent years as a result. It is no surprise that when asked about the sector, the most popular response among investors (46%) was that retail represents a major risk and that they would not invest at all. However, more than half (54%) would at least consider investing selectively, while almost a quarter (23%) view the sector as an opportunity, with investment either likely or being actively sought.

Consequently, there is likely to be an increase in acquisitions over the second half of the year. Many retail assets are proving resilient, and while store numbers will undoubtedly fall in the coming years, the assets that remain will see improved performance. Through careful selection, more investors will take advantage of the current weak sentiment and softening pricing to purchase good retail assets.

“Transaction levels were notably lower in Q2, and we expect this to continue through at least Q3 as the political situation has put a brief pause on many investment decisions, as happened in the second half of 2016 following the EU referendum. Market fundamentals remain strong, with high levels of leasing, low vacancy rates and rental growth offering encouragement to investors. The next development cycle appears to have begun, with many buyers circling value-add opportunities, and a specific focus on the looming supply gap in many major office markets.”Alistair MeadowsHead of UK Capital Markets

“The political uncertainty is undoubtedly having an effect on investor sentiment and market activity, but the UK’s attractions remained broadly undimmed. Investors have significant amounts of capital to invest, and the UK remains a major target, but the majority are waiting for some clarity over Brexit.”Jon NealeHead of UK Research

Contacts

Alistair MeadowsHead of UK Capital [email protected]

+44 (0)20 7852 4092

Jon NealeHead of UK [email protected]+44 (0)20 7087 5508

Himanshu WaniUK Research

[email protected]+44 (0)20 7087 5142

Cameron RamseyUK Research

[email protected]+44 (0)20 7852 4408

capitalmarkets.jll.com/uk© 2019 Jones Lang LaSalle IP, Inc. All rights reserved. The information contained in this document is proprietary to JLL and shall be used solely for the purposes of evaluating this proposal. All such documentation and information remains the property of JLL and shall be kept confidential. Reproduction of any part of this document is authorized only to the extent necessary for its evaluation. It is not to be shown to any third party without the prior written authorization of JLL. All information contained herein is from sources deemed reliable; however, no representation or warranty is made as to the accuracy thereof.

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UK Capital Markets · listed vehicles. Leases are landlord-favourable and longer than other major markets, reducing the risk and increasing the reliability of income streams. International