Market in Minutes: UK Commercial

Is the UK commercial property market well poised for a stronger 2022?

Rising commercial property investment levels in the UK, with yields beginning to trend downwards again, the market is poised for a positive 2022. The occupational drivers, notably hiring intentions by companies and lower unemployment figures, is positive news. However, political issues, energy costs and rising prices more generally have dominated the conversations for the start of this year.

Looking through these (hopefully) transitory issues, which will pass sooner rather than later, there are pockets of good news. In the retail warehouse sector, with no major insolvencies, growing consumer spending and the additional sales driven by click and collect, the sector is showing much lower yields compared to 12 months earlier. Despite the onset and acceptance of hybrid working, there remains confidence in the office sector with some very strong locations, such as Oxford and Cambridge. Overall, initial analysis shows that the office occupational demand data was relatively positive for 2021, with some markets around their five-year average.

In terms of investment volumes, the latest data for 2021 shows that c.£57bn was invested in the UK last year, which is slightly above the five-year average, but a 21% increase on 2020. We expect a 10% increase, compared to 2021, this year.

How have yields moved during the Covid-19 period?

At the start of the year, it is sensible to examine where we believe we are in the current cycle. A review of the recent prime yield shifts is especially relevant.

Before diving into this analysis, it is worth noting that the UK commercial property market is supported by relatively healthy demand and supply fundamentals. As we all know, there remain headwinds on many fronts, but investors remain vigilant for the best opportunities to meet their investment objectives. Their strategies will have been reviewed in the past 24 months, but will now form the backbone of their intentions for the next few years.

Office yields, mainly at the prime end of the spectrum, have remained broadly unchanged despite the commentary in 2020 regarding the death of the office

Steven Lang, Director, Commercial Research

As was discussed above, the investment volumes for 2021 were more positive than would have been expected at the start of last year. This reflects the more positive investors’ sentiment towards the commercial property sector following the significant upward yield shift in April 2020. The chart presents the highest to lowest sector in terms of the current prime yield, and the comparison is to both the ‘Covid peak’ and the preceding five-year average.

The first three sectors are showing current yields much higher than both the peak and the five-year average.

Shopping centres have the highest yield, but with a 121% increase for shopping centres investment volumes in 2021 (albeit off a low base from 2020), which shows the opportunities in the current cycle. Clearly, some investors have a new or renewed appetite to buy into the cycle at the right time to attain future growth.

The retail warehouse sectors were discussed above, but the chart does show the extent of relative attractiveness of the sector with the yields now currently below the five-year average.

Office yields, mainly at the prime end of the spectrum, have remained broadly unchanged despite the commentary in 2020 regarding the death of the office.

The industrial sector, driven by another record-breaking year of occupational demand, has seen yields move significantly and are currently well below the five-year average, in line with West End offices.

As shown in the recently published Savills UK Cross Sector Outlook 2022 report, the sectors covered in this report have return expectations ranging from 4% (shopping centres) to 11.5% (London industrials), per annum on average, during the next five years. Assuming inflation recedes during the course of 2022, which is very likely, this shows commercial property to be an attractive investment.

Any metric that helps us to understand the future drivers and/or scale of demand is, of course, important. There are many metrics available, but an analysis of the venture capital (VC) raising activity in the UK is of particular interest. For the recipient companies, VC is often the vital first step to get its business on a stronger growth trajectory. There is corresponding headcount and revenue growth, which results in real estate demand.

There are two main takeaways from the chart below. Firstly, despite the pandemic, there was a 59% increase in the total level of VC raised by UK-headquartered companies. This will drive additional short- to medium-term demand for commercial property, mainly offices. Secondly, there is a significant share in London, but there is also a ‘rippling out’ to other areas of the UK, where the VC level will impact positively on demand for space in the regional markets.