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For Professional Clients and/or Qualified Investors only

UK PropertyMarket Trends

BMO REP forecasts show positive total returns, averaging 4.3% over five years, underpinned by the income return.

The BMO REP forecasts are based broadly on the consensus economic outlook. A no deal Brexit would adversely affect these forecasts. The latest set of BMO REP forecasts has seen major changes at the sector level and the forecast for 2019 has been downgraded, as have later years.

Contact usUK, London – Head Office

BMO Real Estate Partners7 Seymour Street London W1H 7JW

020 7499 2244

Research

Sue Bjorkegren

sbjorkegren@bmorep.com

Business Development

Jamie Kellett

jkellett@bmorep.com

Telephone calls may be recorded.

Components of BMO REP Forecast All-Property Total Returns – per cent

Source: BMO REP October 2018

Forecasts are provided for illustrative purposes; are not a guarantee of future performance; should not be relied upon for investment decisions; and are subject to change without notice.

Implied Income Return Capital Growth

2018 2019 20212020 2022

Total Returns

-3-2-10123456

November 2018

Key Risks

Our review and outlook is a marketing communication providing an overview of the recent economic and property market environment. It should not be considered as advice or a recommendation to buy, sell or hold investments. Nor is it investment research and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination.

The value of investments and income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

The value of directly held property reflects the opinion of valuers and is reviewed periodically. These assets can also be illiquid and significant or persistent redemptions may require the manager to sell properties at a lower market value adversely affecting the value of your investment.

The economy is continuing to grow but at a sluggish pace. Concerns about Brexit are intensifying and has affected business investment in particular. Globally, economic growth is being sustained, although estimates for the Eurozone have been downgraded.

At the sector level, there is polarisation, with industrials showing strength and retail struggling. Sentiment towards retail has become much more negative, affected by rationalisation and administrations in the sector. The industrial and distribution sectors have continued to drive performance, although there was some loss of momentum in the third quarter. Compared

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Market Snapshot Q3 2018 All Retail Offices Industrial Alternatives

Total Returns 1.7 0.1 1.8 3.5 2.1

Income Return 1.3 1.4 1.2 1.2 1.3

Capital Growth 0.4 -1.3 0.6 2.4 0.8

Rental Growth 0.1 -0.6 0.3 0.8 0.2

Gross Rent Passing -0.1 -0.9 -0.1 1.2 0.5

Net Initial Yield 4.9 5.7 4.5 4.5 4.8

Source: IPD Monthly Digest September 2018. The definition of Alternatives is the Portfolio Analysis Service definition of “other” which includes hotels, residential, leisure etc.

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Three Month Rolling Average All-Property Total Return – per cent to September 2018

Source: IPD Monthly Digest September 2018

Past performance is not an indication of future performance.

2016201520142013 2017 2018

-3-2-10123456

with the previous quarter, south east, rest of UK and West End offices all delivered an improved performance, although City office performance eased after a strong second quarter. Retail was generally weaker, with regional shops particularly affected.

The property investment market has recorded some moderation in activity in 2018, although it remains above the long-run average. Net investment was driven by overseas investors in the third quarter. Institutions remained net investors in property once again during the quarter but this largely reflected a lack of disposals rather than a renewed appetite to buy. Net inflows to retail property funds were positive overall during the quarter. Most parts of the market have seen a weakening in investment activity in 2018 compared with the like period of 2017.

Economic and Property Market Overview

The UK commercial property market is continuing to deliver a solid performance, underpinned by an annual income return of more than 5%, but momentum is slowing.

UK Property Investment Activity – £ million

Source: Property Data November 2018

Overseas Domestic

0

5000

10000

15000

20000

25000

2013 2014 201720162015 2018

Past performance is not an indication of future performance.

The UK is under-performing the US and the Eurozone, and this is expected to persist for at least the next two years.

The BMO REP forecasts are based broadly on the consensus economic outlook and would be revised adversely in the event of a no deal Brexit. Although the latest set of BMO REP forecasts has seen the 2018 all-property total return forecast little changed from that made three months ago, there have been major changes at the sector level and the forecast for 2019 has been downgraded, as have later years.

The major factor behind the downgrades is the expected performance of retail property. The retail sector has faced severe structural challenges and, with a few exceptions such as Central London, we have been forecasting under-performance for some time. The past few months have seen a spate of administrations and rationalisations and a marked deterioration in investor sentiment towards the sector. Yields are moving out and trending weaker. We believe that that a major re- rating of the sector could be in prospect. The latest BMO REP forecasts are considerably more pessimistic than the latest Investment Property Forum (IPF) Consensus Forecasts published in August 2018.

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The Economic and Property Market Outlook

We are now much more pessimistic about the prospects for retail property but have upgraded our forecasts for Central London offices and industrials.

Consensus GDP forecasts for the UK in 2018 and 2019 have been unchanged over the past three months, with modest but positive growth predicted. However, these forecasts could be subject to considerable revision as the Brexit negotiations progress. We expect some dislocation in the immediate aftermath of the March 2019 deadline. A “no deal” Brexit could be sufficiently disruptive to herald a period of negative GDP growth. Inflation is predicted to decelerate towards the Bank of England target. Interest rates are expected to move higher, but at a gradual pace. Consensus expectations are for the next increase in bank rate to occur in 2019, but for the official rate to be only 1% in a year’s time. The government has indicated that austerity is ending, but the scope for fiscal manoeuvre could be limited. The last Budget before the Brexit deadline took place on 29th October and there will be an emergency budget if there is no deal. The Brexit process is complex and there could be political as well as economic ramifications involving a possible change of leader or of government in due course.

Internationally, global growth is being sustained but the International Monetary Fund believes that it may have peaked in several major countries and that downside risks have increased. There are political and economic headwinds in several countries including the US, Germany, Italy, the Middle East and China.

Consensus Real GDP Forecasts – per cent

Source: Consensus Economics October 2018

UK Eurozone US

2018 2019 2022202120200.00.51.01.52.02.53.03.5

BMO REP Forecast Total Returns by Segment end 2017-end 2022 – per cent per annum

Source: BMO REP October 2018

Forecasts are provided for illustrative purposes; are not a guarantee of future performance; should not be relied upon for investment decisions; and are subject to change without notice.

Standard retailShopping centresRetail warehousesCity officesWest End officesSouth Eastern officesRest of UK officesStandard industrialDistributionAlternativesAll-Property

-4 -2 0 2 4 6 8 10

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There have also been some upgrades. We have been conservative in our forecasts for Central London offices in the aftermath of the Brexit vote. However, investment activity, supported by overseas buying, has held up well, occupational demand is reasonable and projections of Brexit-related job losses have been reduced. We are fairly cautious given the uncertainty around Brexit but our projections are now much closer to the IPF Consensus over the period to 2022.

We have upgraded the 2018 and 2019 forecasts for standard industrials and distribution, reflecting the continued strength in these markets. However, there may be little scope for further yield compression and some rental growth expectations could prove optimistic. We expect these markets to continue to out-perform but not to the extent seen over the past year or so.

We believe that alternatives will continue to grow in importance and as a class may deliver out-performance in terms of total returns, although the diversity of the assets which comprise the segment needs to be recognised.

The income return is predicted to remain fairly steady to average around 4.7% pa in the five years to 2022. Rental growth is expected to be fairly subdued and focused on industrial/distribution and alternatives.

The longevity of the property cycle upswing has been extended by the prolonged period of low interest rates. Despite the economic uncertainty, consensus forecasts are for ten-year gilt yields to remain below 3% until 2022 which may provide support to the market. There are health warnings on retail and the extent to which the long-term risk premium could change under different Brexit/political scenarios but consensus expectations indicate that upward pressure on all-property yields is not imminent when judged against the risk-free rate.

There are longer-term issues affecting property, including changes in technology, infrastructure, working and shopping patterns and demography, as noted in previous reports. These will offer opportunity and present challenges.

The property market has delivered several years of positive annual total returns but may now be entering a more mature phase of the cycle. Property still benefits from a relatively high and stable income return, long-term contracted income and an established, large and mature investment market. We are forecasting a period of positive total returns, underpinned by the income return.

Perceived Stage of the Property Cycle

Source: RICS October 2018

Forecast Yield Gap – percentage points

Sources: IPD Monthly Digest September 2018, Consensus Economics October 2018, Bank of England

0

1

2

3

4

5

6

2018 2019 2020 2021 2022

Long-Term Risk Premium 2001-2018

Consensus Gilt Yield Forecast Initial Yield Sept 2018

Early Downturn

% of Respondents

Mid-Downturn

Bottom

Early Upturn

Mid-Upturn

Peak

27%

11%

8%

13%

20%

21%

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Microsoft HQ, Reading 4 The Square, Stockley Park 40-41 Old Bond Street, London

Overseas buyers active in London and in the regions

Valesco and AIP of Korea are set to buy the Microsoft HQ in Reading for £100m at a 6.6% yield.

NPS of Korea has bought Plumtree Court, the Goldman Sachs HQ, for £1.16bn at a 4.1% yield.

Local authorities are buying – within their own districts and beyond

Woking Borough Council bought the former Toys R Us in the town for £9.5m.

East Hampshire District Council has bought a business park in Warwick for £13.2m at a 6.99% yield.

A search for yield

Regional REIT has bought a portfolio of eight office assets for £31.4m at an 8.7% yield.

Town Centre Securities bought The Cube office and leisure scheme in Leeds for £12m at a 12.5% yield.

Investment demand for some south east office assets

AEW sold its South East offices portfolio to Ares for £140m at a 7.2% yield.

Dimah Capital of Kuwait has bought 4 The Square, Stockley Park for £34.5m at a 6.55% yield.

A weak retail investment market but some activity occurring

Tribeca sold the Cartier unit in London’s Old Bond St for £65m at a 2.72% yield. Gallagher shopping park in Wednesbury was sold for £175m to Hana Financial of Korea.

Only two shopping centres reported as completing in the third quarter – at Weston super Mare and Ipswich.

Alternatives in demand

Student accommodation – Singapore Press Holding has paid £180m for 14 assets at a 6.3% yield.

Hotels – Sidra Capital of Saudi Arabia has bought the Travelodge at Heathrow for £40m at a 5% yield.

Industrials – low yields and forward funding

Yields on transactions in Croydon and Thamesmead were at 3.26% and 3.66% respectively.

Tritax is forward-funding an £89m scheme for Bosch in Corby at a 5.2% yield.

Growing importance of build to rent (BTR)

Invesco has paid £400m for 1000 BTR units in Kew and Barking.

Realstar of Canada is investing £100m in BTR in Wembley and New Cross.

Long income still favoured

Aberdeen Standard has bought the Legoland hotel in Windsor for its Long Lease Fund. It has 28 years unexpired.

Key Transactions Data

© 2018 BMO Real Estate Partners LLP. Registered in England and Wales with number OC338377. Registered Office: 7 Seymour Street, London W1H 7JW. BMO Real Estate Partners LLP, BMO REP Asset Management Plc and BMO REP Property Management Limited are members of the BMO Financial Group and are subsidiaries of the Bank of Montreal. CM18308 (11/18) UK, CH.

LEGAL INFORMATION

This document:

• has been issued and approved by, and is the sole responsibility of, BMO REP Asset Management plc of 7 Seymour Street W1H 7JW (“BMO REP”) which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (registration no. 119283).

• is for professional investors/advisers only and the information in it may not be appropriate for all persons in all jurisdictions in the world. By accepting this document, you represent and warrant to BMO REP that you are an appropriate person to receive such information.

• should not be considered as nor constitute as any investment, tax, legal or other advice and you should obtain specific professional advice before making any investment decision. Nor is it an offer or solicitation to deal in any of the investments or funds mentioned in it, by anyone in any jurisdiction in which such offer or solicitation would be unlawful or in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation.

• contains confidential information belonging to BMO REP and/or third parties and is supplied to you solely for your information and may not be forwarded to any other person, reproduced or published in whole or in part for any purpose.

No representation or warranty, express or implied, is given by BMO REP or any other person as to the accuracy or completeness of the information or opinions contained in this document. Save in the case of fraud, no liability is accepted for loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information or opinion contained in this document. BMO REP Asset Management plc is a subsidiary of BMO Real Estate Partners LLP and are members of the BMO Financial Group, which is itself wholly-owned by the Bank of Montreal.

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