Property market
Recent months have seen the UK property investment market move into a downturn in the face of rising interest rates and the slide into recession. Occupier markets are showing initial signs of deceleration, and we expect them to be in a downturn by the Summer.
Some open-ended property unit funds have now imposed restrictions on the payment of redemptions, which is usually a sign of investor uncertainty. This will probably lead to some stock coming to the market for sale as the funds move to raise cash.
Rolling investment volumes across the UK in the year to November 2022 totalled £61.9 billion, which is down on the October figure of £66.4 billion, but just ahead of the long-term average of £59.0 billion. Sales volumes in recent months have been ebbing.
Offices
Office rental value growth decelerated in December, with the MSCI Market Rental Growth Index for offices growing by 0.09%, compared to 0.15% in November. We are forecasting rental growth to turn negative in the coming months given the difficult economic backdrop.
The Big Nine regional city markets recorded nearly 2.0 million sq ft of take-up in Q3 2022, which is up on the 1.8 million sq ft recorded in Q2. This is below the 10-year average for a Q3 of 2.3 million sq ft.
London’s office market saw take-up reach 2.4 million sq ft in Q3 2022, which is down slightly on the 2.5 million sq ft let in Q2. The vacancy rate edged up changed to 7.7%. This is above the mid-pandemic figure of 7.5%, but lower than the mid-GFC peak of 8.0%.
The MSCI capital value growth Index for Offices decreased by -3.3% month-on-month in December 2022, compared to the November figure of -4.8%. This marks the sixth consecutive negative monthly figure.
Big Nine investment volumes reduced by 65% quarter-on-quarter to £299m for Q3 2022. This was the lowest quarterly sales volume since Q2 2020, during the first wave of the pandemic, which highlights how cautious the market has become.
In Central London, Q3 saw just £2.4 billion of deals transacted (vs £2.7 billion in Q2), and of this over a third was made up of one deal, namely T Corp’s purchase of 21 Moorfields, EC2, for £809 million reflecting a yield of 4.6%.
In the year to November 2022, £16.1 billion was invested in UK offices, which is down on the £17.3 billion in the year to October. Office sales volumes have been gradually falling since their May peak of £21.8 billion.
Retail
In December 2022, UK retail footfall was 9.9% higher than the same month in 2021, according to Springboard. Compared to December 2019, footfall was down by -10.9%.
High streets saw a 12.7% increase in December footfall on an annual comparison, while shopping centres were up by 10.3% and retail parks by 3.6%. Springboard warned “the first quarter of 2023 will be challenging for retail”.
Late January saw the stationers chain, Paperchase, go into administration, with Tesco buying the brand and intellectual property of the group. The supermarket will not be taken on any of the 106 shops and 820 staff. There is growing concern about tenant covenant strength following some high-profile administrations in recent months.
The MSCI retail rental growth index flatlined in December 2022, following declines in October and November. The improved performance was partly due to a return to growth for retail warehouses (0.08%).
Retail capital values are declining with the MSCI index falling by -2.7% month-on-month in December, compared to -5.2% in November, marking the sixth consecutive negative monthly figure. Retail property investment stood at £7.1 billion in the year to November 2022, compared to £6.9 billion in October.
Industrial
The MSCI industrial rental growth index grew by 0.54% month-on-month in December 2022, compared to 0.58% in November 2022. This was the strongest rental growth from the main sectors, but nevertheless marks a slowdown for industrial property on earlier in the year. Back in June 2022 rental growth stood at 1.1%.
Take-up of Grade A Big Box space over 100,000 sq ft totalled 30.2 million sq ft in Q1-Q3 2022, according to Avison Young figures, which was down on the 40.3 million sq ft in the same period of 2021. Current supply stood at 24.0 million sq ft at the end of September, which is up from 20.8 million sq ft in June.
Given the growing significance of ecommerce to the industrial market, it should be noted that online shopping sales value fell by -8.9% in the year to December 2022, and was down -2.9% month-on-month. However, Royal Mail strikes may have encouraged more physical store shopping late last year.
Investment volumes for industrial assets stood at £14.0 billion in the year to November 2022. This was down from £15.4 billion in the year to October, but well above the £7.7 billion figure for the year to December 2019.
The Industrial sector has seen a marked decline in capital value growth recently. The MSCI index for industrial fell by -5.0% month-on-month in December, compared to -7.6% in November, its sixth consecutive negative reading.
Housing market
The Nationwide House Price Index reported a 1.1% increase in the year to January 2023, down from the 2.8% figure for December. Month-on-month the index fell by -0.6%. This marked the fifth month of values falling compared to the previous month.
The average two-year fixed rate mortgage deal reached 5.4% in late January 2023 according to Money Facts, up from 4.1% in late August 2022. However, this is down on the October peak of 6.5% seen in the aftermath of the Truss government’s mini-budget.
In December 2022, 36,000 mortgages were approved, according to the Bank of England, which was down sharply on the November figure of 46,000 and the pre-Covid average of 66,800 per month in the year to February 2020.
During the September mini-budget the government raised the level at which Stamp Duty Land Tax (SDLT) applies from £125,000 to £250,000 in England and Northern Ireland. For first time buyers the level will increase from £300,000 to £425,000. This is a welcome move, although the sharp rise in mortgage rates in recent months and the slowdown in the economy are likely to outweigh the benefits from increasing SDLT thresholds.
There is a loose correlation between consumer confidence and house prices. Given the squeeze on household incomes from high inflation and rising mortgage rates, and the shrinking economy, we expect to see house prices slide further in 2023.
Outlook
For both the commercial and residential property markets the high level of economic uncertainty and evidence that prices are correcting have encouraged a ‘wait-and-see’ attitude among real estate investors. In many markets there are reports of a significant mismatch between buyer and seller expectations on pricing.
The impact of the difficult economic conditions seen in the last year, plus the expectation of a recession in 2023, is evident in the investment market indicators. Occupier markets are for now holding up reasonably well, but this is probably due to a time lag, and we expect to see a downturn this year.
MSCI data showed a marked fall in capital values in October, which probably related to quarterly valuations, and again in November and December. We therefore suspect another significant drop in values will be reported in the January data with the next major round of valuations.
The figures currently suggests that of the main sectors industrial is seeing values fall the fastest, probably because it performed the strongest pre-downturn. Nevertheless, pricing is also under pressure for retail and offices. That the consumer is experiencing a major income squeeze means that retail, leisure and hospitality property are facing tough market conditions in the coming months.
1.5 That some open-ended funds have gated will probably lead to sales, and the very fact of them imposing restrictions has weighed on sentiment. It has been reported in the media that some pension funds want to reduce exposure to illiquid assets, including property.
1.6 We see the market as now in a downturn but expect prime assets to see demand and pricing hold up best; particularly those buildings with strong sustainability accreditations, which are fast becoming a fundamental requirement for investors and occupiers.
1.7 We now believe that at 4.00% the base rate is now either at or close to its peak, although we do not anticipate a cut until well into 2024. With interest rates high by the standards of the last decade, investors are seeking higher yields, which is placing pressure on vendors.
1.8 Anecdotally, there is significant dry powder on the side lines monitoring the situation, with a view to deploying ahead of the turning in the property cycle. This bodes well for when signs emerge that the low point of the downturn has been reached, but we believe that moment is still months away.
1.9 In the residential market, house prices are falling in the face of the cost of living crisis and higher interest rates. We are forecasting prices to continue to slide throughout 2023.
1.10 Across most occupier markets, demand is likely to ease as businesses and households look to contain costs, at least until inflationary pressures fall away significantly. This will probably act as a drag on rental growth and some sub-sectors might see rents fall, particularly for poor quality space. Incentive packages will probably become more generous in 2023.
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