UK Economy & Property Market Chart Book September 2009

Published September 22nd 2009

Overview

September 2009

Pages 1 2: Economic overview. Key business surveys signal that UK economic output will begin to edge up in the third quarter albeit at a moderate pace. Although the recovery is likely to be export led, its durability will also depend on the behaviour of household spending. At this stage, households still appear focused on scaling back debt levels.

Pages 3:

Financial market indicators.

Pages 4-5: Construction sector. Construction output has so far fallen further and faster than the wider economy. Funding brought-forward for Government projects, as well as recent news that housebuilders have resumed work on some mothballed sites, should gradually help lift output. Confidence in the sector is beginning to stabilise but at very low levels.

Pages 6-7: Housing market. Measures of underlying price momentum indicate a sharp upward trend in house prices. This is being driven by the combination of moderately rising demand and low levels of property on the market. The short run price and activity indicators point to continued improvements in both areas. But house prices are still expensive according to basic valuation metrics.

Pages 810: Commercial property. Recession continues to weigh on the occupier market exerting downward pressure on rents while pushing up on rental voids. However, the pace of rental declines is now moderating and capital values are beginning to stabilise. Commercial property yields compare increasingly favourably against equities and bonds on a relative valuation basis.

RICS UK Economy & Property Market Chart Book

Economic overview
Key business surveys signal that UK economic output will begin to edge up in the third quarter, albeit at a moderate pace after a peak to trough fall of 5.5% (see chart 1). The latest (July) official data show that industrial production has stabilised and manufacturing production increased by 0.9% (on a three month on three month annualised basis). However, manufacturing and industrial production are still 10.1% and 9.3% below their respective year ago levels (see chart 3). Although exports are likely to lead the economic recovery, its durability will also depend upon household spending. Recent trends in this area have been mixed; the pace of contraction in consumption eased in Q2 (-0.7% vs. -1.3% in Q1). More timely retail sales data conveys a slightly more positive picture with the three month on three month growth rate edging up from 1.1% to 1.2% in August. On a year on year basis (latest three months on comparable period in 2008), sales volumes rose by 2.7% although this improvement is heavily influenced by base effects (see chart 2). There are several factors restraining household spending including relatively high household indebtedness, job uncertainty and the expectation of future tax rises.

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Economic overview (contd)

CPI inflation fell to 1.6% in August, the lowest level since October 2004 (see chart 4). The Bank of England expects CPI to continue falling in the coming months, possibly below 1% . Such falls are likely to be principally driven by technical factors i.e. because of the large increases in domestic energy prices dropping out of the twelve-month comparison, although they could be exacerbated by the weaker picture in wage settlements. The scheduled VAT rise to 17.5% on January 1st 2010, will, however begin to reverse this trend. The ILO unemployment rate hit 7.9% in July taking the number of unemployed workers to 2.47m. The labour market is likely to further deteriorate in the coming months, but recent improvements in survey measures of unemployment expectations and hiring intentions indicate that the pace of job shedding is likely to slow (see chart 5). Falling inflation unemployment expectations are helping to lift consumer confidence. Meanwhile, industrial confidence is recovering on the back of improved output expectations. Production was cut aggressively during Q4 2008 and Q1 in order reduce the inventory overhang (see chart 6).

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Financial market indicators

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Construction Sector
Construction output has so far fallen further and faster than the wider economy. In 2009 Q2, GDP was 5.5% below its peak at the start of 2008 but construction output was down by 15% (see chart 11). Funding broughtforward for Government projects, as well as recent news that housebuilders have resumed work on some mothballed sites, should gradually help lift output from this low level. Volume of new construction orders are a lead indicator of construction output. So far this year, the data imply that construction activity is still weak in an historical context. Extrapolating from the first half of the year, construction new orders in 2009 may reach just over 30bn - but that would be 18% lower than the total for 2008 and only two-thirds of the annual average for construction new orders over 2003 to 2007 (See chart 12). Private sector construction has been responsible for most of the contraction in overall spending. Looking forward, confidence, as measured on the EC survey of builders, seems to be stabilising. But that is not yet much reason for optimism as the net balance is still hovering around rock bottom and at - 68, in August confidence has been at the same low level for 3 months (see chart 13).

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Construction Sector (contd)

In July 2009, private housing construction orders increased by 16% on the month but, even after that, they were still 16% lower than July 2008. It now seems that this sector has reached a trough (see chart 14). Modest further increases are expected over the rest of 2009. Construction orders for public housing increased by almost 50% between June and July a sign that the increase in Government funding for Registered Social Landlords is starting to have some effect. Private sector commercial construction orders have continued to fall sharply (down 52% y/y in July 2009) while industrial construction has virtually dried up altogether (see chart 15). Given banks reluctance to risk funding future developments, construction activity in this sector is unlikely to improve much over the rest of 2009. Although volatile, spending on infrastructure and public non-residential construction has not suffered so badly through the downturn. In fact, since the end of 2008, spending in these two sub-sectors has trended upwards (see chart 16). This sector is vulnerable to a public spending squeeze in the medium term. But in the short term, growth will continue as Government spending is brought forward to ease the effects of the downturn.

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Housing market
Taking an average of the Nationwide and Halifax house prices indices, prices were down by 5% in the year to August, compared to the low point of 18% reached in February. Measures of underlying price momentum, such as the 3 month on 3 month annualised growth rate, indicate a sharp upward trend in house prices (see chart 17). This is driven by the combination of moderately rising demand and low levels of property on the market. On the demand side, the resurgence in new buyer enquiries has continued apace (see chart 18). However, the Bank of England's June Credit Conditions Survey suggested that financing remains tight and this may be preventing some of the pick-up in buyer enquiries from translating fully into approved mortgages. In addition, the recovery is from a very low level and, in an historical context, housing transactions are still quite weak. On the supply side, low mortgage rates are also alleviating the degree of household financial stress and thus limiting forced sales. However, improved sentiment has seen some vendor interest return to the market. RICS Housing Market Survey data show that in August, surveyors reported an average net increase of 23 properties coming to the market compared to 7 in July (see chart 19).

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Housing market (contd)

The short run price and activity indicators point to continued improvements in both areas. The RICS price expectations balance, covering the next three months, reached 17 in August, the highest level since March 2007 (see chart 20). The net balance of surveyors reporting an increase in sales expectations has edged back slightly (from +40 in May to +29 in August) but that still broadly reflects increased transactions in the coming months. The RICS sales to stock ratio is a gauge of market slack and lead indicator of short-run price movements. As a result of rising demand and falling supply, the sales to stock ratio has risen for eight consecutive months, reaching 27% in August, up from a low of 13% in December 2008 (see chart 21). But this improvement is from a very low base and could unwind if the flow of property for sale increases in the next few months. As such, the recovery in house prices seen to date is still relatively fragile. House prices are still expensive according to basic valuation metrics such as the house price to earnings ratio (HPE). The recent increases in house prices mean that the Nationwide first time buyer HPE actually increased in 2009Q2 - another 30% fall in house prices is required for it to fall back in line with its long run average (see chart 22.)

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Commercial property
Recession continues to weigh on the occupier market exerting downward pressure on rents while pushing up on rental voids. Significantly, the Q2 RICS Commercial Market Survey highlighted that the rental declines are likely to moderate across all three sectors of the market. Indeed, the rental expectations net balance in the retail sector fell to -52 from -85, in the office sector the net balance fell to -69 from -83 and in the industrial sector the net balance fell to -44 from -73 (see chart 23). This moderation in the pace of rental decline anticipated by the RICS survey has been borne out in the IPD data. In August, the three month on three month annualised pace of decline moderated from 9.0% to 8.5% in the retail sector, from 15.9% to 12.5% in the office sector and from 6% to 5.3% in the industrial sector (see chart 24). Rental voids, which are a reflection of income lost from empty properties as a proportion of total income, reached 12.3% in August for all property, the highest level in the history of the series (December 1994). Again, this figure masks considerable sectoral variation; retail sector voids stood at 9.1%, office sector voids stood at 13.6% and industrial sector rents stood at 18.2% (see chart 25).

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Commercial property (contd)

Unlike the divergence in rental performance, capital values have fallen by broadly similar amounts in all sectors (see chart 26). However, the short term growth dynamics indicate that capital values are beginning to stabilise. Indeed, IPD data shows capital values increased for the first time in 26 months in August. On a three month on three month annualised basis, capital values are now falling 9.6% in the retail sector, 12.8% in the office sector and 8.9% in the industrial sector. While oversupply may be important in some areas, the fact that capital values have fallen so uniformly across sectors suggests more systemic forces have been at work i.e. the credit crunch. This has, at least for the time being, put an end to securitised commercial property lending, which during the boom had been the main channel used to finance transactions. With the pace of decline in rents almost catching up with the pace of decline in capital values, yields are now showing signs of stabilising. Initial yields, which only factor in current rental levels, for all property have remained at 7.9% since June (see chart 27). On a sectoral basis, initial yields are 7.5% in the retail sector, 8.1% in the office sector and 8.2% in the industrial sector (see chart 28).

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Commercial property (contd)

In August the all property initial yield stood at 7.9% (and has been at this level since June). To put this in the context of other investment yields, the FTSE All share dividend yield stood at 3.48% in August (currently 3.31% in mid September) and the 10 yr Gilt yield stood 3.71% (currently 3.69% in mid September) (see chart 29). Commercial property yields compare increasingly favourably against equities and bonds on a relative valuation basis. Indeed, commercial property has been looking cheap compared to bonds for some time now, but only very recently has it started to look good value compared to equities (due to the strong rally in the share prices in the past few months). The spread between the all property initial yield and the FTSE All Share dividend yield rose above its long run average (3.15%) in May (for the first time since April 2004) and in August reached 4.38%, the highest level since May 2002 (see chart 30). The spread between the all property initial yield and the 10yr Gilt yield stood at 4.1% in August and is well above its long run average of 1.2% (see chart 31). Given the falls in the 10yr Gilt and FTSE All share dividend yields since August, the spread between both of these and the initial yield is likely to have widened further.

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September 2009
RICS is the worlds leading qualification when it comes to professional standards in land, property and construction. In a world where more and more people, governments, banks and commercial organisations demand greater certainty of professional standards and ethics, attaining RICS status is the recognised mark of property professionalism. Over 100 000 property professionals working in the major established and emerging economies of the world have already recognised the importance of securing RICS status by becoming members. RICS is an independent professional body originally established in the UK by Royal Charter. Since 1868, RICS has been committed to setting and upholding the highest standards of excellence and integrity providing impartial, authoritative advice on key issues affecting businesses and society. RICS is a regulator of both its individual members and firms enabling it to maintain the highest standards and providing the basis for unparalleled client confidence in the sector. RICS has a worldwide network. For further information simply contact the relevant RICS office or our Contact Centre.

RICS can help Government to deliver a vibrant and sustainable property market. RICS is committed to standards and professionalism. Drawing on its members expertise around the globe, RICS is well placed to advise on the contribution that a well functioning property sector can make to the national and global economy. RICS members operate in every aspect of property and can deliver practical market-based solutions to challenges facing Government. RICS internationally recognised standards in valuation of real property can underpin the maintenance of a sound economy. RICS members have a leading role to play in delivering the market transformation required to move towards a low carbon economy. Contact: Economics@rics.org T +44 (0)20 7334 3890

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