The current UK economy and its effect on commercial real estate
Since Q3 2022 the UK economy has been contracting. This is a culmination of both domestic and global factors. The UK has struggled with political instability, rising interest rates and an imbalance of property stock to demand. Meanwhile, overseas issues like geopolitical conflicts, Covid and currency rate fluctuations have also contributed to a weaker UK market. The commercial property market is directly affected by the UK economy’s performance, implying that within the next 12 months, issues within our economy may trickle down into the wider commercial market.
Flight to quality changes
The process of flight to quality is the herd-like movement of investors where funds are shifted out of assets deemed volatile and put into less risky alternatives. It often happens during times of financial downturn as historically these periods highlight how the safer investment usually yields healthier returns in the long term.
Due to market conditions, we can predict that the average investor will be more deterred from risky asset classes for example sub-prime retail units or retail warehouses. Instead, we will likely see more investment focused on the asset classes which can provide more reassurance of returns for example prime retail in thriving cities.
Flight to quality is cyclical therefore alluding to the allocation of funds back into riskier investments. We can expect this to occur once the UK market shows signs of recovery however we cannot forecast this as timescales of recessions are notoriously varied.
The silver lining to the government’s handling of the economy would be current plans to counteract GDP decline. The forefront of this agenda is the Freeport scheme.
The government have outlined nationwide zones linked to our coast where taxes/fees are minimised and, in some areas called ‘customs sites’, abolished in order to generate jobs, garner demand domestically and stimulate growth.
The first three confirmed Freeports, Plymouth, Solent and Teeside received approval on 7th December, and each will receive £25m in seed funding for further development.
In Southampton alone, we have observed how the integration of a new Freeport zone has boosted investment. We expect to see private sector investment into the region of £1.35bn. To understand more about Solent Freeport check out our guide.
From an investor’s perspective, vigilance is key when navigating acquisitions. Values of commercial property within freeports rise significantly once zones are finalised highlighting the importance of staying up to date with reports and liaising with local authorities.
This reignited commercial interest in the UK’s coastline may be pivotal in how the country tackles its recession. Some may speculate that the focus on ports may sway investors away from opportunities in the midlands however only time will tell.
‘New era’ for investment following the mini-budget.
One notable event in 2022 was the government’s mini-Budget in response to the cost-of-living crisis. This was immediately followed by the sharp de-value of the pound and has implications for the commercial property market.
The fastest repricing of market yields in recorded history occurred in the latter half of 2022, leading to a resurgence in activity followed by price stability in 2023. This could be a once-in-a-lifetime buying opportunity for some investors in certain sectors. However, the post-global financial crisis era has ended and investors must approach this as a new phase where income will play a key role in driving total returns across major asset classes.
We can expect to observe how asset classes will shift in attractiveness due to repriced market yields.
Office investment – Reduced office occupancy levels will be a result of an increase in subleasing. Despite the shortage of UK offices with high environmental ratings and a decrease in speculative construction due to a tighter loan market, growth in prime office rental is still achievable.
Retail investment – Shops in suburban and commuter high streets will perform well while bulk retail warehousing will continue to suffer due to its innate dependence on big-ticket item sales. The high-income return on offer should, however, mean that this sector delivers some of the best commercial property total returns over the next five years.
Industrial & Logistics investment – Overall, the industrial sector is underperforming due to a stark imbalance of supply & demand. In spite of this, the logistics sector is set to perform well in accordance with recent years. Yields are expected to stabilise sooner than other sectors following the period of sustained repricing. Forecasts imply that Logistics will sustain its attractiveness to investors and continue to be a major contributor to total real estate investment.
The office leasing industry will experience slower growth as a result of declining office employment (caused by flexible working) and the current economic climate. Office space take up is likely to be lower in 2023 than seen in 2022.
Underperformers will be buildings that fail to match environmental goals, have poor location/quality and fail match modern work styles – units with high parking provisions less desirable after the shift to flexible working.
During 2023, prices will stabilise, which should encourage more investment activity. With most deals concentrated in the second half of the year, office investment volumes are predicted to be 20% lower in 2023 compared to the previous year.
The majority of the office space that is being built or renovated and scheduled to be finished in 2023 has already been pre-let. Even though overall levels of demand are declining, there will still be a high need for development or renovation because of strong demand for the highest quality space.
Research concludes that office employment to decline by roughly 1% is anticipated in 2023. All markets will be impacted by the loss in office jobs, but Central London will have a less pronounced decline than other markets. Due to declining employment levels, take-up throughout UK office markets is predicted to shrink by 7% in 2023 compared to 2022 levels, which is only slightly higher than trend levels.
While the overall narrative of the 2023 retail market sounds unsettling, some sub-markets still show promise and will remain appealing to investors. Costar named high street shops in affluent commuter towns and London suburbs in their ‘Top Commercial Investment Picks for 2023’. This is down to the potential for capitalising on agile working related shifts in consumer spending.
The chart below highlights the projected rise in retail business/store failures. We can observe a positive trend in failure post crises (recession or pandemic), if this pattern continues we can anticipate a continued rise in retail failures through 2023.
Industrial & Logistics outlook
With vacancy rates forecasted to stay at critically low and poor take-up levels due to a lacking supply of available units, it will be a rough start to the year for the industrial market. Furthermore, constraints such as higher exit yields and rising construction costs are only painting a harsher picture for the 12 months ahead.
Due to the imbalance between supply and demand, rental growth will persist. In comparison to the quarterly double-digit rental growth levels seen through 2021 and early 2022, the growth rate will be less rapid.
Non-prime locations – Although occupiers will continue to prioritise buildings in historically prime sites, we anticipate an increase in take-up for buildings in “off prime” or secondary locations. The lack of buildings in desirable locations that suit occupiers’ requirements as well as the reasonable rents in these places will be the driving factors for this. Additionally, we anticipate a rise in the number of occupiers seeking properties close to significant rail hubs so they can potentially save money on transportation while also lowering their carbon footprint.
While the narrative for some markets is daunting due to an amplified perception of risk both domestically and internationally, we must appreciate that this presents opportunities for alternative asset classes to flourish. The appetite for investment is still strong. Here at Omega RE we take into consideration your business strategy and evaluate the best possible option for your real estate needs. We acknowledge the challenges on the horizon of 2023. Instead of dwelling on these, we look forward to tackling them and hope the rest of the industry shares our optimistic approach.
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About Omega RE
Omega RE is a commercial property advisory firm based on the South Coast. Providing expert advice to Landlords, Occupiers in the industrial, office and retail markets.
Omega RE is always thinking ‘Outside the Box’ in our advice to clients and the way we do business. We don’t settle for mediocre, we challenge the norm and are dedicated to finding solutions that is best for our clients.
We are a people business, based on strong relationships and partnerships, and we offer a personal level of service.
As the market evolves, we will too adapt to be successful and want the same for our clients. We are committed to finding innovative ways of marketing and how to do things more efficiently.
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Providing clients’ with a hands-on approach to finding the perfect property; office, industrial, warehouse or retail space to meet business needs and negotiating the best commercial lease terms, is what we do best.
We come to work because we’re passionate about providing expert, innovative, independent advice to clients. We want to help businesses navigate the complexities of Commercial Real Estate.
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