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Market in Minutes: UK Commercial

A mathematical dilemma: How a rise in base rates is impacting market pricing and investment volumes




With base rates in the UK rising to 1.25% from 0.1% in a little over six months and further rises seen as an inevitability, the market is entering a period of navel-gazing as investors take stock and wait for evidence of market pricing.

The sudden and dramatic change in sentiment is reflected in the investment volume numbers, as whilst the overall level at £25.4 billion for H1 is 20% above the long-term average, monthly volumes have been trending downward since the start of the year with just £8.3 billion transacted in Q2, the lowest level since Q2 2020 during the height of lockdown restrictions. Pre-Covid, you have to go back to 2012 for a lower quarterly investment volume.

It is clear that in many markets the definition of prime has become tighter and is not representative of the market in general. This is reflected in our yield movements this month which saw City offices, logistics and multi-let industrial all move out by 25 bps, with further outward movement expected for industrial and logistics, raising our average yield by 4 bps to 4.79%. These markets are most impacted by geared overseas investors, whereas markets with smaller lot sizes and a higher proportion of equity investors, such as West End offices, retail warehousing and High St retail, where yields moved in by 25 bps, are currently more insulated from the volatility around the cost of debt. As we explore below, the primary driver for this pricing correction remains on the financial side rather than undue concern about the occupational markets.



Occupier markets remain strong across the board

As the months have passed in 2022, it is clear to see that sentiment in economies the world over has changed dramatically. Consumer confidence has fallen to the lowest level since records began, and whilst retail sales are still showing increases in value, the volume of sales has been declining steadily since October 2021, according to data from the ONS. Even online retail levels, where momentum seemed unstoppable, have fallen to 25.9% of all retail sales, the lowest level since before the onset of Covid-19. Given this economic backdrop, history would tell us cracks in the occupational markets would start to appear, but at the time of writing, there is little to suggest that this is the case.

In the logistics market, take-up has reached 28.6m sq ft for H1, 91% above the long-term average and setting a new record in the process. Vacancy remains structurally low at just 3.01%, and even if Amazon returned 10% of their stock to the market, which we do not anticipate, vacancy would still be below the five-year average.

One of the most positive trends we have seen in the retail warehouse market of late is the appetite for new units from operators across all product categories

Kevin Mofid, Head of Logistics & Industrial Research, Commercial Research

In the City, year-to-date take-up has reached 2.3m sq ft, 70% above the same point last year and 5% above the 10-year average. Across the wider London market, vacancy has trended upward and now sits at 8.1%, but occupier preference for good-quality units is demonstrated by the fact that 93% of the space under offer is for Grade A units which, in turn, is expected to put upward pressure on rents.

In the regional office market, vacancy has fallen to 9.4%, 300 bps lower than the long-term average, and occupier demand is edging towards pre-Covid levels for the first time since the onset of the pandemic.

One of the most positive trends we have seen in the retail warehouse market of late is the appetite for new units from operators across all product categories. 2021 saw the number of new openings match exactly with that seen in 2019 at 1,021, the highest recorded in the 11 years that Savills has been capturing this data and far in excess of the 855 unit average of that period. This pattern of new openings looks set to continue with 433 new openings agreed by the end of Q1 this year.

We expect vacancy to remain low, and in certain markets falls, as investors dial back their attitude to construction risk. With low vacancy and rising demand, we remain confident of rental growth prospects.



Particularly relevant for the industrial, logistics, manufacturing and science sectors is the fact that global supply chains remain stretched in the post-Covid recovery, a situation being amplified further by ongoing events in Ukraine and China's zero-Covid policy.

Companies are now actively exploring opportunities to bring manufacturing closer to the point of sale and increase inventories in order to remain competitive. Indeed, recent data from Sentieo, which analyses listed companies' annual reports, has found that mentions of the term 'near-shoring' have risen dramatically in 2022. We are starting to observe new occupier requirements directly related to this phenomenon and expect demand to rise as companies come to terms with running 'just in case' supply chains rather than 'just in time'.