Will we be able to reach our pre-Covid optimism biased with the current climate?

For the cost-of-living crisis and inflation pressures to come so quickly on the heels of Covid feels like it has robbed us of our usual optimism bias. Consumers are clearly pulling back, concerned just how much of their household budget will get swallowed by energy and fuel costs. For the real estate sector, so too have investors paused over Q2 – largely without exception across retail, office and industrial.

A year on from the Covid-19 uncertainties that haunted us through the first half of 2021 (and of course the whole of 2020), uncertainty persists today but in a different form. How well the economy can weather the inflationary pressures is the key concern. Whilst other G7 countries are experiencing inflation too – the UK is slightly different as it is a combined impact of high energy costs (also a problem for the rest of Europe) and a tight labour market (also a problem for the US). The Bank of England in its August meeting certainly added to the growing sense of concern, forecasting a recession akin to the early 1990s and inflation over 10% for much of next year too.

Rapidly rising interest rates are a problem for debt-backed investors and also for those investors who evaluate property on its yield spread over government bonds. This yield spread is quickly diminishing as interest rates rise – bond yields have increased from 0.82% in June 2021 to 2.38% in June 2022 (even ahead of the latest rises in base rates). Whilst for the most part yields held steady over Q2, even improving in some sectors, the trend is now reversing.

All real estate sectors have a reason to be cautions. In addition to concerns on the economy, the office market is working towards a new hybrid working normal at potentially lower long-term levels of demand. The retail sector is most at risk from the consumer slowdown and the industrial sector, whilst running very strong for the last year and a half, may now see the bull run approaching its final few yards. Tentative evidence suggests investors are being more cautious and occupiers are starting to struggle with the high level of rents.

The fall in investment volumes over Q2 may well mark a turning point for the market with yields under more pressure and an increased sense of caution evident amongst investors.