8th June 2021
In response to the fear of sustained inflation, the policy maker’s monetary response is moving equity and bond markets on both side of the Atlantic right now. Inflation is clearly rising in the UK, so here is why real estate in Kent offers an alternative for long term, index linked investment returns.
Sustained Output Growth
Rising oil prices, household gas and electricity bills pushed UK inflation to 1.5% in April according to the UK Office of National Statistics May inflation report. Compared to rises of 0.7% in March and 0.4% in February, this has made analysts sit up and take notice. Fuel prices are the major input that feeds through to cost increases in consumer goods.
April also saw UK manufacturing growth gathering pace for the 11th consecutive month. High demand for raw materials and the Brexit hangover supply chain issues, also pushing up input prices.
Most pertinently for real estate, UK construction activity continues to grow nicely. Consequently, the rate of construction input cost inflation has also risen. In fact, to its highest levels since 1997. According to IHS Markit, higher prices were paid for a wide range of construction items in quarter one including steel, timber and transportation.
This month, City AM reported a positive tone from the group chief executive at SCAPE, the UK’s leading public sector procurement authority, “Despite the outlying risk posed by continued materials and skills shortages, the sustained output growth we’ve seen since January cements the construction industry’s position at the heart of the economic recovery.”
Economic theory says that when higher inflation pushes interest rates up, or just the threat of it, house prices generally fall. House prices relationship with consumer price inflation has conditioned us to watch the Bank of England’s response, as this outcome depends upon monetary policy. If the Bank accommodates higher inflation, then house prices will hold up. If monetary policy is tightened, house prices and demand will fall back.
The Bank of England has said that it expects inflation to rise further this spring and predicts it will then settle down. In other words, they are indicating they are unlikely to tighten monetary policy through tapering quantitative easing or hiking interest rates, until 2022 at least. However, there is a growing chorus of economists that predict inflation will go much further and for longer than the Bank thinks. And there are plenty of boardrooms concerned about the potential inflation resulting from a full-throttle economic recovery.
Big Changes to Property
Behind this story of soaring growth and threatening inflation sits the biggest change to property in several generations. There has been a national decline in food and beverage and retail rental values because changing shopping habits and the pandemic reduced demand. Economic recovery in the short term will ease pressure on these rental payments. Every landlord is now reassessing sustainable levels of rents, not least in Kent’s town centres.
Industrials, especially big box logistics have continued to do well in Kent, fuelled by the drive for delivering ecommerce to London. But also, through the post Brexit play; after all, no part of the UK is better connected to supply chains in Europe and beyond with high speed trains, short ferry crossings and a vast choice of ports offering unaccompanied freight services.
It has become clear that long distance supply chains are susceptible to external shocks. Near-shoring operations and de-globalisation of manufacturing is becoming an important trend – for many companies the labour cost arbitrage of having production offshore is starting to become less pronounced now that wage costs are rising in Asia. We are supporting some very large manufacturers to invest in Kent on this basis. Either moving from locations in the UK that are too far from ports or moving back from Europe where labour markets are less flexible. We believe this is a long term trend and will continue beyond 2025.
Adapting to Agile Working
The changes to the way we work may lead to less aggregate office demand in Kent, but offices themselves are adapting to accommodate greater flexibility of working practices. IWG has shown that rental income generated is sustainable in the long-term with flexible and coworking spaces outside major cities. See our last property blog.
While it would be tempting to expect the same again in 2021, the reality is more nuanced. With fewer commuting to London from Kent in the foreseeable future thanks to our mass agile working experiment, demand for flexible office space in Kent is showing signs of heightened demand. With reduced demand for retail and less stringent requirements to change use, more office workspace is coming through in high streets in buildings previously used for selling fashion or used as council offices.
At Locate in Kent, we don’t believe in the death of offices. We are seeing tenants becoming much more selective about what constitutes the modern ‘white collar’ workplace. Landlords and developers are responding to that as well, by being more selective in the properties they’re targeting. New offices must be flexible, sustainable, deliver technology and have amenities such as wellbeing, fitness or childcare close by.
We also see differentiation in the management of individual assets becoming important. Building owners need to future proof their assets to protect future cash flows by matching the users’ ESG values. That means greener buildings that suit people’s changing lifestyles. Energy efficiency and renewable energy sourcing (e.g., solar panels). Workplaces with showers and green areas for them to eat their lunch to stimulate wellbeing need to be baked in, like at the forthcoming Innovation Park Medway, Kingstanding in Tunbridge Wells and Crossways in Dartford. Cycle to work schemes and locations with proximity to public transport like Ashford are also attractive propositions.
Let’s not forget investment in Kent’s housebuilding.
As the professional exodus from London to Kent increases, despite the Stamp Duty holiday ending, there are opportunities to invest in alternate real estate assets. That includes long-term, inflation-linked cash flows from building and leasing Doctors’ surgeries, social housing, student accommodation and supermarkets.
Short term Risks, Long term Gains
The commercial property sector clearly has some short-term risks to get through as the vaccine roll out proceeds and we see periodic regional Covid breakouts, like in the North West. However, The Bank of England’s monetary policy will remain supportive for the sector and Kent real estate has historically performed well in a climate of recovery. The right property asset classes can deliver inflation-adjusted capital and income returns in a portfolio over time; you just need to base them at the epicentre of the growth. And that could be in Kent.
Simon Ryan is our Investment Director. He works with businesses and property developers to make Kent an even more appealing place to work and grow businesses. Click here for his contact details >>