Is The Commercial Property Market Recovering?
This article was first published in Property Investor News, May 2024
Since Liz Truss’s ‘mini budget’, in September 2022, the commercial property market has been in a downward trajectory caused by higher interest rates (fuelled by high inflation and higher ‘risk free’ bond yields), significant socio-economic change fuelled by Brexit and the pandemic, and a lack of confidence in the market. Whilst this has caused pain for commercial property owners, it has also opened up a ‘Window of Opportunity’ for investors to buy commercial at lower prices from more motivated sellers.
As we navigate through 2024, I hear much talk, particularly from commercial agents, of the ‘green shoots’ of a recovery. This is predominantly fuelled by the weight of demand for commercial real estate, in some sectors, as well as the anticipation of interest rates slowly starting to come down this summer, making commercial debt more affordable. So is the ‘Window of Opportunity’ still open?
Key Metrics for Evaluating Recovery
To assess the health of the commercial property market, several indicators tend to be crucial:
1. Occupancy Rates
High tenant occupancy rates generally signal strong demand for commercial spaces, suggesting business confidence and operational expansion.
According to the latest survey of the market from the Royal Institution of Chartered Surveyors (RICS), tenant demand increased by 4% in the first quarter of 2024, up from a -7% net balance at the end of 2023, with industrial sectors showing the most robust growth since the third quarter of 2022 at a net balance of +14%. Office spaces also saw an increase in demand, the first since early 2022.
However, demand for occupational space is becoming more regionally, and sectorally, divided. In London, office demand has increased from +3% to +40%, while in other parts of the UK, demand remained stagnant or slightly declined.
Retail demand is stronger in London compared to other regions, while industrial property demand continues to be positive across most areas.
2. Rental Growth
Increasing rental prices indicate rising demand and a scarcity of available property, which are positive signs of market recovery. In this, all-property trends mask significant variation, depending on the type of property and location – there is most definitely a clear division between the ‘haves’ and the ‘have nots’ in the market.
Prime rental levels in the industrial and prime office sectors have proved resilient in London and the larger regional cities, reflecting the focus of occupier demand towards top-quality space of which there is little available stock. The rental gap between grade A and grade B stock is likely to widen further.
Similarly, average retail rental values remain nearly 17% below their previous peak in 2018, according to Carter Jonas, and the all-retail trend masks significant variation, depending on the type of property and location. For example, the retail warehouse subsector has performed much better than most of the wider retail sector in recent years, with average rental values increasing by 1.1% in the 12 months to March 2024 (Carter Jonas) whereas there have been falls in rents in many locations nationwide.
3. Investment Volumes
A rebound in investment volumes can often signal confidence in the market’s long-term prospects. However, these have continued to be depressed nationwide.
According to industry indices, £8.1bn was traded in Q1 2024. Whilst this seems a lot, this was down 14% quarter-on-quarter, down 25% year-on-year and 40% below the five-year quarterly average. The rolling annual total also fell to 37% below the five-year average. The office and industrial sectors saw volumes continue to fall in Q1, whilst activity in the alternative sectors saw an increase as funds look to move away from the traditional commercial market sectors and diversify their portfolios.
Notably, just over 45% of total investment occurred in London in Q1 2024 (Carter Jonas).
4. Yield Compression
When investment yields decrease, it typically indicates an increase in property values and investor confidence.
Commercial yields have moved out by at least 2% since their peak (Savills) – some sectors showing much more notable increases. Only one sector is now starting to see yield recovery – and that is prime industrial, notably logistics, fuelled by the weight of occupier demand in that sector.
It is likely that across most sectors, yields will not start to come down until base rates decrease – there is an expectation that this will happen this summer, but that prime yields going forwards will not necessarily return to where they were pre-2022, as base rates are likely to trend higher. Similarly, until bond yields start to fall more significantly, commercial yields will remain high.
5. Development Activity
An uptick in construction and development projects shows optimism in future market growth and is a robust indicator of recovery.
The main development activity in the market is currently centring around the repurposing of secondary space – notably in the secondary office market. Development activity in the logistics space continues, fuelled by demand, but there is little retail and office space development other than in very prime locations.
Development finance is currently very expensive and that, coupled with increased build costs and poor market sentiment, has meant that many developers have retrenched.
6. Market Sentiment
Market sentiment, the overall attitude of investors and consumers towards the market, significantly impacts commercial property. It is both a cause and effect of the underlying economic conditions and can often be a self-fulfilling prophecy. Positive sentiment can drive investment and development, even in an objectively uncertain market, while negative sentiment can stifle growth despite favourable economic indicators.
The recent RICS survey indicated an increase in sentiment from investors and agents active in the market, but there is a still a long way to go to reach the peaks witnessed pre pandemic.
Lessons from Past Downturns
Historical downturns in the commercial property market provide valuable lessons. For instance, the 2008 financial crisis taught us that recovery can be protracted and uneven across sectors and regions. However, in the sectors that recover first, recovery can be rapid – by 2011 a lot of prime office and retail property had recovered and was starting to reach yields seen pre-2008. The Window of Opportunity can often be short!
Implications for SME investors
So how do we make conclusions about our own investing?
It is clear that 2024 continues to represent a fantastic opportunity to buy commercial property at the bottom of the cycle.
However, in the current market, the only rule is there are no rules….! Make sure you understand how the market operates so that you can seize all the opportunities out there! The UK commercial property market is far from homogeneous, and each sector exhibits unique characteristics and reacts differently to economic pressures….. knowledge is power!
For example, many high street shops and shopping centres, nationwide, have struggled with a gulf between supply and demand, but retail warehousing, particularly in the south-east of England is performing well. There is good demand for prime offices, but many secondary offices lie vacant, with some being ripe for repurposing to residential and co-working space.
Regional disparities also play a crucial role. London and the south east’s market dynamics often differ significantly from other parts of the UK. I’m watching auction lots carefully at the moment and, whilst we are seeing properties in receivership going into auctions nationwide, I am observing some real bargains in areas outside of the southeast, but pricing being a lot more competitive for decent assets in London and the South East.
Having read a lot of market analysis and come to conclusions from my own investing it is clear to me that the current ‘Window of Opportunity’ (WOO) will continue throughout 2024, as we see continued economic uncertainty and a General Election. This is a once in a decade opportunity – if you have sat on the fence about starting to invest in commercial, then now is the time to get off it and take the first steps to invest. Retail looks cheap, there are great repurposing opportunities in the office sector, and industrial will return strong when markets improve.
The best ways to take advantage of this are as follows:
- Find your own investing niche & build relationships in that space;
- Actively seek out motivated vendors (including properties in receivership / auctions / direct to vendor / off market with agents);
- Buy cash (owners and agents are looking for speed and certainty in this market);
Savills’s recent market report sums it up perfectly ‘…when things change they change fast: the ‘fear of missing out’ can be a powerful driving force for real estate investors. As soon as a critical mass of deals takes place, a snowball effect can take hold with more and more buyers coming back to the market. The trick is to be the investor at the front of the queue. Timing is everything: it always has been, and always will be.”
Now is the time to invest in the Window of Opportunity!
To find out more about the Window of Opportunity download Suzi’s WOO report at https://www.windowofopportunity.uk
