The famous quote from Franklin D Roosevelt’s first inauguration address seems relevant after a week when the Bank of England has hung its forecasting hat on a view that is more negative about the short-term outlook for the UK economy than any of its peers.
There is no doubt that consumer (and to a degree business) sentiment is at, or is close to, record lows, and that this will have a dragging effect on tenant demand for real estate in particular. However, much of this isn’t new news, and the resilience of the commercial property market in the face of a succession of confidence shocks points to a brighter future than the headlines might suggest.
The first half of 2022 saw record levels of leasing activity in the UK logistics market and take-up 13 per cent above the long-term trend in the London office market. Prices on many imported items have fallen back from their early Q2 peaks and recruitment levels suggest that businesses remain in growth mode. While the impact of the energy price cap on inflation is not going anywhere in the short term, there is firm evidence that elsewhere in the economy the upward pressure on prices is easing.
The one area of commercial property where confidence is clearly having an effect is office development, where longer lead times and delays to starts are beginning to suggest that the level of completions in 2025/6 could be much lower than we expected at the start of this year. Given the rising bias in tenant demand towards 'prime and green' (53 per cent of space leased in central London in H1 2022 was BREEAM Excellent or Outstanding), any tightening of the forward pipeline will result in more undersupply of the most in-demand space, and hence stronger than expected upward pressure on prime rents.
Once construction price inflation has cooled, and most cost consultants are suggesting that it will, the higher rents that are achievable on the best space will increase the viability of assets going from brown to green. Thus, while our short-term view on rental growth might be weaker due to occupier caution, the medium term is looking more positive.
The biggest forward challenge to the commercial property market remains the one we were talking about three months ago: the impact on retail property of consumers tightening their belts. However, rents have rebased enough in many locations that rental stresses are less likely to drag on retailer performance than a few years ago, and from an investor’s point of view the very high yields on offer in retail property are still a lure.
Confidence is everything in the property markets and if nothing else the succession of shocks that we have seen over the last half dozen years shows us that the ability to look beyond short-term volatility is the key to remaining calm. The rapid repricing that we have seen over the last three months suggests that we aren’t hiding our heads in the sand, something that past shocks have shown us is seldom a good strategy.
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