Septermber Economic Chart Book

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UK Economy & Property Market Chart Book

September 2009

Published September 22nd2009


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Pages 1 2: Economic overview. Key business surveys signal that UK economic output will begin to edgeup in the third quarter albeit at a moderate pace. Although the recovery is likely to be export led, its durability will alsodepend 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: Construct ion sector. Construction output has so far fallen further and faster than the widereconomy. Funding brought-forward for Government projects, as well as recent news that housebuilders have re-sumed work on some mothballed sites, should gradually help lift output. Confidence in the sector is beginning to sta-bilise 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 themarket. The short run price and activity indicators point to continued improvements in both areas. But house pricesare still expensive according to basic valuation metrics.

Pages 810: Commercial property. Recession continues to weigh on the occupier market exerting down-

ward pressure on rents while pushing up on rental voids. However, the pace of rental declines is now moderating andcapital values are beginning to stabilise. Commercial property yields compare increasingly favourably against equitiesand bonds on a relative valuation basis.

Overview September 2009

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Key business surveys signal that UK economic output will begin to edge upin the third quarter, albeit at a moderate pace after a peak to trough fall of5.5% (see chart 1). The latest (J uly) official data show that industrial pro-duction has stabilised and manufacturing production increased by 0.9%

(on a three month on three month annualised basis). However, manufac-turing and industrial production are still 10.1% and 9.3% below their re-spective year ago levels (see chart 3).

Although exports are likely to lead the economic recovery, its durability willalso depend upon household spending. Recent trends in this area havebeen 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 morepositive 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 monthson comparable period in 2008), sales volumes rose by 2.7% although thisimprovement is heavily influenced by base effects (see chart 2).

There are several factors restraining household spending including rela-tively high household indebtedness, job uncertainty and the expectation offuture tax rises.

Economic overview September 2009

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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 thecoming months, possibly below 1% . Such falls are likely to be principallydriven by technical factors i.e. because of the large increases in domestic

energy prices dropping out of the twelve-month comparison, although theycould be exacerbated by the weaker picture in wage settlements. Thescheduled VAT rise to 17.5% on J anuary 1st 2010, will, however begin toreverse this trend.

The ILO unemployment rate hit 7.9% in J uly taking the number of unem-ployed workers to 2.47m. The labour market is likely to further deterioratein the coming months, but recent improvements in survey measures of un-employment 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 consumerconfidence. Meanwhile, industrial confidence is recovering on the back ofimproved output expectations. Production was cut aggressively during Q42008 and Q1 in order reduce the inventory overhang (see chart 6).

Economic overview (contd) September 2009

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Financial market indicators September 2009

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Construction output has so far fallen further and faster than the wider econ-omy. In 2009 Q2, GDP was 5.5% below its peak at the start of 2008 butconstruction output was down by 15% (see chart 11). Funding brought-forward for Government projects, as well as recent news that housebuild-

ers have resumed work on some mothballed sites, should gradually helplift output from this low level.

Volume of new construction orders are a lead indicator of construction out-put. So far this year, the data imply that construction activity is still weak inan historical context. Extrapolating from the first half of the year, construc-tion 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 forconstruction new orders over 2003 to 2007 (See chart 12). Private sector

construction has been responsible for most of the contraction in overallspending.

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 thenet balance is still hovering around rock bottom and at - 68, in August con-fidence has been at the same low level for 3 months (see chart 13).

Construction Sector September 2009


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In J uly 2009, private housing construction orders increased by 16% on themonth but, even after that, they were still 16% lower than J uly 2008. It nowseems that this sector has reached a trough (see chart 14). Modest furtherincreases are expected over the rest of 2009. Construction orders for pub-

lic housing increased by almost 50% between June and July a sign thatthe increase in Government funding for Registered Social Landlords isstarting to have some effect.

Private sector commercial construction orders have continued to fallsharply (down 52% y/y in J uly 2009) while industrial construction has virtu-ally dried up altogether (see chart 15). Given banks reluctance to riskfunding future developments, construction activity in this sector is unlikelyto improve much over the rest of 2009.

Although volatile, spending on infrastructure and public non-residentialconstruction has not suffered so badly through the downturn. In fact, sincethe end of 2008, spending in these two sub-sectors has trended upwards(see chart 16). This sector is vulnerable to a public spending squeeze inthe medium term. But in the short term, growth will continue as Govern-ment spending is brought forward to ease the effects of the downturn.

Construction Sector (contd) September 2009


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H i k S b 2009


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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 pointof 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 combina-tion of moderately rising demand and low levels of property on the market.

On the demand side, the resurgence in new buyer enquiries has continuedapace (see chart 18). However, the Bank of England's J une Credit Condi-tions Survey suggested that financing remains tight and this may be pre-venting some of the pick-up in buyer enquiries from translating fully intoapproved 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 ofhousehold financial stress and thus limiting forced sales. However, im-proved sentiment has seen some vendor interest return to the market.RICS Housing Market Survey data show that in August, surveyors reportedan average net increase of 23 properties coming to the market comparedto 7 in J uly (see chart 19).

Housing market September 2009

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H i k t ( td) S t b 2009


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The short run price and activity indicators point to continued improvementsin both areas. The RICS price expectations balance, covering the nextthree 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 indicatorof short-run price movements. As a result of rising demand and falling sup-ply, the sales to stock ratio has risen for eight consecutive months, reach-ing 27% in August, up from a low of 13% in December 2008 (see chart21). But this improvement is from a very low base and could unwind if theflow of property for sale increases in the next few months. As such, therecovery in house prices seen to date is still relatively fragile.

House prices are still expensive according to basic valuation metrics suchas the house price to earnings ratio (HPE). The recent increases in houseprices mean that the Nationwide first time buyer HPE actually increased in2009Q2 - another 30% fall in house prices is required for it to fall back inline with its long run average (see chart 22.)

Housing market (contd) September 2009

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C i l t S t b 2009


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Recession continues to weigh on the occupier market exerting downwardpressure on rents while pushing up on rental voids. Significantly, the Q2RICS Commercial Market Survey highlighted that the rental declines arelikely to moderate across all three sectors of the market. Indeed, the rentalexpectations net balance in the retail sector fell to -52 from -85, in the of-fice sector the net balance fell to -69 from -83 and in the industrial sectorthe net balance fell to -44 from -73 (see chart 23).

This moderation in the pace of rental decline anticipated by the RICS sur-vey has been borne out in the IPD data. In August, the three month onthree month annualised pace of decline moderated from 9.0% to 8.5% inthe retail sector, from 15.9% to 12.5% in the office sector and from 6% to5.3% in the industrial sector (see chart 24).

Rental voids, which are a reflection of income lost from empty propertiesas 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, thisfigure masks considerable sectoral variation; retail sector voids stood at9.1%, office sector voids stood at 13.6% and industrial sector rents stoodat 18.2% (see chart 25).

Commercial property September 2009

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Commercial property (contd) September 2009


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Unlike the divergence in rental performance, capital values have fallen bybroadly similar amounts in all sectors (see chart 26). However, the shortterm growth dynamics indicate that capital values are beginning to stabi-lise. Indeed, IPD data shows capital values increased for the first time in26 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 officesector and 8.9% in the industrial sector.

While oversupply may be important in some areas, the fact that capitalvalues have fallen so uniformly across sectors suggests more systemicforces have been at work i.e. the credit crunch. This has, at least for thetime being, put an end to securitised commercial property lending, whichduring 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 de-cline in capital values, yields are now showing signs of stabilising. Initialyields, which only factor in current rental levels, for all property have re-mained at 7.9% since J une (see chart 27). On a sectoral basis, initialyields are 7.5% in the retail sector, 8.1% in the office sector and 8.2% inthe industrial sector (see chart 28).



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In August the all property initial yield stood at 7.9% (and has been at thislevel since J une). To put this in the context of other investment yields, theFTSE 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% inmid September) (see chart 29).

Commercial property yields compare increasingly favourably against equi-ties and bonds on a relative valuation basis. Indeed, commercial propertyhas been looking cheap compared to bonds for some time now, but onlyvery recently has it started to look good value compared to equities (dueto the strong rally in the share prices in the past few months).

The spread between the all property initial yield and the FTSE All Sharedividend yield rose above its long run average (3.15%) in May (for the firsttime since April 2004) and in August reached 4.38%, the highest levelsince May 2002 (see chart 30). The spread between the all property initialyield and the 10yr Gilt yield stood at 4.1% in August and is well above itslong run average of 1.2% (see chart 31). Given the falls in the 10yr Giltand FTSE All share dividend yields since August, the spread betweenboth of these and the initial yield is likely to have widened further.

Commercial property (cont d) September 2009


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September 2009


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September 2009

RICS can help Government to deliver a vibrant and sustainable propertymarket. RICS is committed to standards and professionalism. Drawing on itsmembers expertise around the globe, RICS is well placed to advise on thecontribution that a well functioning property sector can make to the nationaland global economy.

RICS members operate in every aspect of property and can deliver practicalmarket-based solutions to challenges facing Government. RICS internation-ally recognised standards in valuation of real property can underpin the main-

tenance of a sound economy. RICS members have a leading role to play indelivering the market transformation required to move towards a low carboneconomy.

Contact:

[email protected] +44 (0)20 7334 3890


RICS is the worlds leading qualification when it comes to professionalstandards in land, property and construction. In a world where more andmore people, governments, banks and commercial organisations demandgreater certainty of professional standards and ethics, attaining RICS status isthe recognised mark of property professionalism.

Over 100 000 property professionals working in the major established andemerging economies of the world have already recognised the importance ofsecuring RICS status by becoming members.

RICS is an independent professional body originally established in the UK byRoyal Charter. Since 1868, RICS has been committed to setting and uphold-ing the highest standards of excellence and integrity providing impartial, au-thoritative advice on key issues affecting businesses and society.

RICS is a regulator of both its individual members and firms enabling it tomaintain the highest standards and providing the basis for unparalleled clientconfidence in the sector. RICS has a worldwide network. For further informa-tion simply contact the relevant RICS office or our Contact Centre.

Septermber Economic Chart Book

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