What does the Government’s 2.5% economic growth target mean for real estate?

Is the ambition achievable?

Recently appointed Chancellor, Kwasi Kwarteng, has announced an ambition to raise UK economic growth to a trend rate of 2.5% per annum. Is this achievable and what is the relevance for real estate?

The Chancellor is right to be worried about growth. Whilst 2.5% is the average annual rate of UK economic growth from 1950 up until 2019 (before the impact of the pandemic), it has only reached or exceeded this rate in six of the last 20 years (one of which was the post-pandemic bounce-back). 

In the 1950s and 1960s, growth averaged 3.3% per annum (assisted by post-war rebuilding), slowing to 2.6% per annum in the 1970s and 1980s and 2.2% per annum in the 1990s. The 2000s saw just 1.6% growth, although this decade was impacted by the global financial crisis and concluded with output still in the recovery phase. Growth did rise to 2.0% per annum in the 2010s, but only achieved 2.5%+ in two out of ten years. 

Clearly, economic growth has trended downwards during the post-war era, and 2.5% per annum should not be somehow regarded as a ‘natural’ rate. The UK is not alone, with many advanced economies facing a similar issue. Together with the current economic headwinds (both UK-specific and global), returning to a trend rate of 2.5% per annum would appear to be extremely challenging. 

This is backed up by economic forecasters. In the short-term, Experian’s forecasters are projecting an average of only 0.9% per annum over the three years from 2022 to 2024 (although there is a high degree of uncertainty given the current economic turmoil). 

Even over the medium term, most economists expect growth to average well below 2.5% per annum. Based on Experian forecasts, it will average only 1.7% per annum from 2025 to 2035. This is a significant gap with the Government’s aspiration - economic growth of 2.5% per annum from next year rather than the forecast rate would result in the UK economy being 15% larger by the end of 2035. 

Interlinked with output growth is population. While output growth has broadly decelerated, the UK’s population growth has accelerated in recent decades, as Figure 1 illustrates. An increasing share of output growth has been simply due to a rising population rather than productivity gains. This is reflected in the weak productivity growth figures we have seen in recent years, particularly since the global financial crisis of the late 2000s. To achieve a higher rate of economic growth, productivity must rise significantly.

Figure 1:

Source: ONS, Carter Jonas

How does economic growth affect real estate performance?

Figure 2 illustrates how the total return for commercial property reflects the economic cycle. Sometimes performance anticipates GDP growth, whilst at other times, investors anticipate a recovery that does not materialise. Investors may ‘see through’ a short-term issue (the pandemic, for example), or they may overreact (as in the immediate aftermath of the Brexit referendum result). 

Figure 2:

Source: ONS, MSCI, Carter Jonas

Although commercial property returns tend to anticipate or reflect changes to economic growth, the overall investment performance of commercial property in real terms is less correlated with economic growth over the long term, as Figure 3 shows. Taking the four decades over which we have good property performance data, the 1980s and 1990s were the strongest for economic growth, whilst the 2000s and 2010 saw the strongest inflation-adjusted property returns.

Figure 3:

Source: ONS, MSCI, Carter Jonas

Whilst the long-run economic growth rate underpins occupier demand, other factors are at work on the supply side. Development activity has been subdued in recent economic cycles, limiting the potential for oversupply of high quality space. Importantly, the significant shifts in demand brought about by the remote shopping and working revolution means that long-term structural demand / supply imbalances are now arguably more important than the economic cycle. This is leaving some property sectors exposed to structural oversupply, and others to structural undersupply, impacting rental growth and investor returns. 

The importance of population and employment growth

Economic growth is important, but it links most directly to real estate through some of its specific drivers such as population and employment growth. Additional people need somewhere to live, shop, enjoy recreational activities and work. 

However, population growth is slowing. Over the next decade, projections by the ONS suggest that growth will be just 0.3% per annum, compared with 0.7% per annum during the 2010s. Population growth is therefore unlikely to drive output growth to the extent is has done in recent decades. 

That said, growth of 0.3% per annum still represents nearly 2 million people. Furthermore, the demographic impact is not just about overall growth, but also about the shifting nature of the population, with population growth focused on the elderly, for example. 

Indeed, the number of people under the age of 20 is projected to fall at a rate of -0.6% per annum over the next decade, with modest growth in those aged 20-69 (+0.2% per annum). The population aged 70+ however will see a growth rate of 1.7% per annum. The additional population will add to the current backlog of housing, and especially so in the later living / care home sector. 

With the UK’s unemployment rate now down to just 3.6% (the lowest since 1974) full employment is one of the key constraints to economic growth. It is also of particular importance to commercial real estate, as despite the remote working revolution, employment growth remains a key source of commercial property demand. But the minimal growth in the working age population will act as a speed limit on employment, increasing the focus on productivity gains through the implementation of technology.

Whilst it is tempting to conclude that productivity gains through greater efficient and technology do not benefit real estate, our forthcoming research on the impact of artificial intelligence on office demand argues that this, too, can have a positive impact. 

Levelling up

The Government’s much-discussed aspiration to ‘level up’ regional disparities could potentially play a significant role. Measured in terms of GVA, the UK economy grew at a rate of 1.8% per annum over a 20-year period to the end of 2019 (pre-pandemic). However, Greater London is in a league of its own at 2.9% per annum, either broadly in line with, or below the average. Even the South East and East regions managed only 1.9% per annum, although there are pockets of strong performance, with Oxford achieving 2.1% per annum and Cambridge achieving 2.6% per annum, for example. The northern regions of England averaged only 1.7% per annum (although there are also pockets of higher growth).

Increasing the UK’s economic performance outside of London will help. But this must not be at the expense of London, which will remain the UK’s main growth engine as a global hub for financial and professional services, and the technology sector. 

Helping to drive the target

Perhaps it is more relevant to ask our initial question the other way around: how can real estate help drive the Government’s 2.5% economic growth target? In many locations where economic growth is strong, a shortage of property is acting as a constraint on growth – whether this be housing that is affordable to the majority of the workforce, high quality office space, or urban logistics sites. Property also has a central role to play in the UK’s transition to a low carbon economy, which will be an important source of economic growth over the next several decades. 

Of key importance will be the policy initiatives the Government deploys to assist the property industry in delivering the built environment necessary for this growth to occur – including the importance of supply side reforms highlighted in the Chancellor’s Growth Plan. 

New policy initiatives will be vital across a multitude of areas ranging from planning policy and infrastructure investment to business rates, a deliverable ‘levelling up’ strategy, and funding in areas such as renewable energy, education, and science & technology.

To conclude, real estate has a central role to play in helping the economy to achieve the productivity gains that will be required for this growth rate to be achieved. The opportunities to develop the right property in the right locations are immense. Reaching an average growth rate of 2.5% per annum is a huge challenge that will require a step change in the UK’s productivity performance. Real estate can both benefit from, and be instrumental in, achieving it. 

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