Today the Chancellor Jeremy Hunt delivered his first Autumn Statement, unveiling a package of measures designed to rebuild the UK’s reputation with the financial markets. The contrast with Kwasi Kwarteng’s disastrous “mini” budget in September could not have been starker, unveiling a £55bn package of measures comprising £25bn of tax rises and £30bn in spending cuts. The statement focused on shoring up public finances which will in turn help to bring down borrowing costs for both the government and the wider economy.

From a real estate market perspective, the most significant implications lie in three main areas:

• in the short-term, how the financial markets react;
• over the coming quarters, how the economy performs and longer term, the plans for capital investment and spending designed to boost growth;
• measures to support business, particularly regarding the Rating system.

Financial markets respond calmly

From a financial markets perspective, it was crucial to restore investor faith in the government’s financial management. Ten-year government bonds are the benchmark against which property and other investments are priced. The initial response of the markets was muted, which after last September can be considered a positive. In early trading after the Statement, long bonds and sterling weakened but only very slightly, suggesting that at least the turmoil of the Truss administration is now firmly behind us.

Whilst the unexpected surge in annual inflation to 11.1% in October means that further interest rate rises are a certainty, most of this is already priced into bond yields. The inevitable impact of higher bond yields resulting from recent interest rate rises is still working its way through the real estate market, but the statement firmly aligns the government with economic orthodoxy and fiscal responsibility. This is a helpful step towards creating a more stable environment for businesses and investors, as well as homebuyers, which is a precursor to renewed real estate transaction activity.

Modest fiscal easing during the recession

 

However, as was widely trailed, this comes at a significant cost, with tax rises across the board. As expected, the plan is for a future austerity programme of similar proportions to that rolled out by Chancellor Osborne in 2010, albeit the emphasis this time is more weighted to tax rises. However, much of the retrenchment is deferred for several years – and until after the next election - to minimise the short-term impact on a UK economy that the Government now acknowledges is already in recession. By extending the time horizon for two important “fiscal rules” from three to five years, the Chancellor has actually been able to loosen policy (but only very slightly) over the next two years, requiring an increase in borrowing before the subsequent tightening takes effect in 2025. This loosening will leave the Bank of England with more to do to tame inflation, making further interest rate rises more likely.

The latest forecast from the Office for Budget Responsibility (OBR) is downbeat on near-term prospects for the economy, with GDP expected to contract by 1.4% over 2023 and by 2% peak-to-trough. However, the economy is then expected to grow by 1.3% in 2024, and by over 2.5% in 2025 and 2026. The OBR believes inflation is currently at its peak, at around 11%, declining sharply during next year and expected to turn negative in 2025 albeit this is predicated on interest rates reaching 5%, which is higher than markets currently envisage. Unemployment is forecast to rise from 3.5% to peak at 4.9% in late 2024, which is relatively low in comparison to previous recessions. Overall, the OBR suggests that the Chancellor has around £9bn of “headroom” in meeting his amended fiscal rules, although this could easily be wiped out by higher debt servicing costs if inflation is not brought under control and bond yields were to rise further. The recent rise in interest rates leaves the projected government debt burden at record levels, which is a potential source of future risk.

Significant tax increases ahead

As expected, the Chancellor increased taxes largely through “stealth” measures – reducing or freezing the thresholds and allowances determining who pays tax on what - rather than by increasing the headline tax rate.

Key announcements included:

• reducing the threshold for 45% higher rate income tax from £150,00 to £125,140;
• extending the freeze on other income tax bands until April 2028;
• similar freezes on the inheritance tax and National Insurance thresholds.

There were also more overt tax measures, such as levying road tax on electric vehicles from April 2025, extending and expanding the scope of the energy windfall tax, and cutting relief on share dividends and on capital gains over the next two years. This comes on top of the reinstatement of the rise in Corporation Tax to 25% next April.

Spending cuts but targeted support

As well as the £25 billion of tax rises, there will be £30 billion of future spending cuts. The Chancellor had warned before the Statement that “eye-wateringly difficult” steps would be needed, but with an election on the horizon there were headline-seeking announcements designed to show that the government is looking to protect the most vulnerable. These included:

• extending support for energy bills from April 2023, with average bills rising to £3,000 (rather than the £3,700 that would otherwise have been likely), plus additional targeted support for low-income households and pensioners;
• maintaining the triple-lock uplifts for state pensions, benefits and tax credits which will rise by 10% next April, in line with September’s inflation rate;
• an increase in the National Living Wage by almost the same percentage for over-23s.

It was encouraging that capital spending appears to have been largely protected for now, with renewed commitments to deliver major infrastructure projects including Northern Powerhouse Rail, HS2 to Manchester and the East-West Rail link plus confirmation that the Sizewell C nuclear reactor will be built. However, capital spending will be frozen for three years from 2025, which could hit future projects, and the proposed Investment Zones programme is being “refocussed” around a “limited number of the highest potential knowledge-intensive growth clusters”. The details are yet to be announced but the existing bids for Investment Zones will not be taken forward.

The announcement of an increase in the Energy Profits Levy from 25% to 35%, and a 45% levy on older renewable and nuclear electricity generators, will be widely welcomed. The Chancellor spoke of the drive towards energy independence, a national target of reducing energy consumption in buildings and industry by 15% and emissions by 68% by 2030 (in line with the Glasgow COP26 Agreement), but the policy details of exactly how these encouraging targets will be achieved before the end of the decade remain unclear.

Positive news on Business Rates

For businesses, the most welcome news is that whilst the 2023 Business Rates Revaluation will go ahead, the Multiplier will be frozen in 2023/4, saving business over £9bn. It was also announced that there will be no downwards transition following the revaluation (the Government will carry the burden of £1.6bn), so businesses occupying property where the rateable value has fallen will see the full benefit from April next year. Upwards Transition will also provide some protection for those seeing rates increases, with caps of 5%, 15% and 30%, respectively, for small, medium, and large properties in 2023-24 (which will be applied before any other reliefs or supplements). Support for eligible retail, hospitality, and leisure businesses is also being extended and increased from 50% to 75% business rates relief up to £110,000 per business in 2023-24. This will cost Government £2.1bn.

Further good news is that concerns of the Government raising extra revenue through an online sales tax have been shelved. Less welcome is that the business sector continues to await the results of a review of energy support measures from next April, which could be an existential issue for many smaller businesses in particular.

Recessionary challenges for occupiers

Currently the biggest concern for the commercial property sector is that the economy is forecast to contract next year to a backdrop of elevated interest rates. The recession is expected to be relatively shallow, with a peak-to-trough fall in GDP of around 2%, so real estate markets are unlikely to face the depth of the problems seen in 2008-2009. However, property yields need to move up to account for increased finance costs. Tenants will be looking to reduce costs, which will encourage footprint consolidation and compound the reduction in occupational demand resulting from a weaker economy. With yields already rising and rental growth set to weaken or turn negative, the year ahead will be challenging for commercial property and there is little in the budget to change that near-term outlook.

Consumer-facing sectors are set to be particularly affected. The government measures to support households announced in September, like the energy price cap, have been counterweighted by higher interest rates. Overall, personal real disposable incomes are expected to fall by a cumulative 7% over the two financial years to 2023-2024, wiping out 8 years of improvement and leaving real incomes in 2027 still 1% below their pre-pandemic level. Property markets like retail, leisure and hospitality face at least another year of difficult trading, following the Covid blighted years of 2020 and 2021. Also, the long bull run for distribution warehouses is likely to moderate, given the outlook for consumption and the fact that online shopping sales volume has been steadily declining this year.

For the financial services sector, an interesting point to note is that the Chancellor has stuck with the plan to reduce the bank surcharge – there had been press speculation the cut would be abandoned. Also, one of the few tax cuts from the September mini-budget still in place is the scrapping of the bankers bonus cap. Post-Brexit, the government has been looking at ways of boosting the financial sector via deregulation. This may mark a reprioritisation of finance by the government, which would bode well for the long-term outlook for offices in the City of London, and other cities with large financial industries, like Birmingham and Edinburgh.

Residential market weakening

The main news for the residential sector was limiting the duration of Stamp Duty Land Tax (SDLT) relief measures announced in September’s ‘mini-budget’. The increase in the nil rate from £125,000 to £250,000 for all purchasers and from £300,00 to £425,000 (on an increased price cap of £625,000) for first time buyers will now end on 31st March 2025. This may have some impact in encouraging transactional activity before the relief expires but we think this is unlikely to make much difference while mortgage rates remain high and house prices are falling.

The OBR’s updated Economic and Fiscal Outlook reveals that they expect house prices to fall by -9% from Q4 2022 and Q3 2024, with larger proportion of this (5.7%) happening in 2024. If this proves to be the extent of house price declines over the next two years, we would consider it a good outcome. However, higher values areas such as London (excluding prime central) and South East are more exposed, as affordability is already stretched. Private housing completions are expected to fall by -11.8% over 2023 and 2024, with the majority of the impact next year.

Away from the private housing sector, we believe Registered Providers will regard the 7% ceiling on the amount they can increase social housing rents for 2023/4 as positive news. It provides certainty for the sector and is the highest of the options that were proposed in a consultation earlier this year (other than leaving the existing CPI+1% uncapped, which was never likely in the current inflationary environment). Along with this, increasing benefits in line with inflation is certainly good news for the sector as it will help mitigate financial pressure on tenants, reducing risk of arrears and bad debts.

Chancellor still walking the tightrope

Overall, the Chancellor appears to have succeeded in maintaining the precarious balance between restoring the credibility of the governments financial management whilst offering some support to mitigate the worst effects of the current recession for households and businesses. The financial market reaction has been modest, which counts as a success. The real estate market will take longer to adjust, with both occupier and investment markets still facing a difficult few quarters ahead.