In response to rising expectations of a stronger recovery in economic growth and higher inflation in Q2, bond yields rose in Q1 leading to a 13.5% fall in values. This was the worst quarterly performance since 1980 with the gross redemption yields on 10 year gilts rising to 0.8%. Given the very wide gap between gilt yields and property yields, we do not envisage a negative property pricing impact. The risk premium relative to the gross redemption yield on 10-year gilts stands at over 400 basis points, a comfortable margin over the long run risk premium of 250 basis points.
Increased positivity towards commercial real estate investment is evident in the MSCI Monthly data series. This shows month on month capital growth over the past 3 months, after falling by 5.8% in 2020. Prospects are improving for most sectors except high street retail and shopping centres.
The IMF has upgraded its UK GDP growth forecasts which it expects to generate faster growth than the US and the Europe with 5.1% expansion this year and next. If achieved, this mean the UK returns to pre pandemic levels of output next year. Other surveys support this view with the UK PMI Construction Index showing rapid expansion with strong job creation. The PMI Services Index also recorded expansion as confidence improves. Deloitte’s UK CFO survey showed business optimism at a 12-year high in January.
Data from Barclaycard shows consumer spending increasing sharply as restrictions on outdoor activities are lifted and mobility increases. Consumers account for 62% of UK GDP and have accumulated an estimated £238 billion in savings during the pandemic. The savings ratio in 2019 was 6.8% and rose to 16.3% last year. Much of this saving was involuntary due to restrictions on eating out, leisure activities, commuting and travel. The UK’s successful progress in rolling out its vaccination programme will play a major role in lifting levels of household confidence. Previous restriction liftings have been accompanied by sizeable consumer ‘revenge spend’ and therefore with a permanent path out of restrictions now in sight, we believe a significant uplift in consumer spending is likely.
At Mayfair Capital we believe that recent surveys from Capital Economics and the IPF understate the returns available from commercial property over the next three years. Investors will be attracted by a combination of relatively high yields and rental growth prospects as consumers and businesses resume activity, driving the economy forward. However, given the return polarisation that we have seen in recent months between and within sectors is likely to be accelerated as a result of structurally-driven change, strong performance will not be universal. There will be winners and losers at an asset level; winners will be those most closely aligned to secular trends implicit in our thematic investment approach.
Risks of course remain but real assets such as commercial property look to have good prospects, particularly compared with fixed interest investments. This relative attraction will increase if inflation is stronger than expected. Savvy investors should act now by increasing their exposure to the commercial real estate sectors most likely to prosper ahead of favourable pricing movement.
James Thornton - Non-Executive Chairman