Commercial market update Autumn 2023

Economy: Interest rate expectations on a knife edge

Will they? Won’t they? This is the key question around whether the UK’s base rate will exceed 5.75%. There have been enough mixed messages to muddy the waters – inflation data released in June showed that inflation was stuck at 8.7% in May, which prompted forecasts that the base rate would peak at 6.5% from the current rate of 5.25%.

But rapid declines in inflation since then, with the headline rate of CPI falling to 6.8% in July, has softened expectations. Yet core inflation data proved more stubborn in July, fuelling some arguments that base rates would indeed need to rise higher than 6% again. A few days after the official inflation data was released, new, and more detailed calculations from the ONS, showed that the core rate of inflation had perhaps fallen more than originally recorded, and once again reduced the forecast for peak base rates. This was underlined by weaker economic data from purchasing managers (PMIs), suggesting that the economy was slowing faster than anticipated, which could mean more downward pressure on inflation.

The lack of decisive data to signal where base rates will peak, and when, and for how long means that every sliver of economic data is prompting more reactions than would be typical in less volatile times. When looking at the outlook for the base rate, the signs from the Bank of England at the last Monetary Policy report were that the base rate may not rise as high as some were forecasting, but would stay at a higher level for longer, although we still expect it to start to fall back later next year.

The rise in gilt yields prompted by sticker-than-expected inflation in Q2 has narrowed the spread against property yields, suggesting room for further softening in all-property yields this year.

The market also remains highly localised. For instance, since the beginning of the year, there has been a 2.1% decline in All Property Capital Values (to the end of July). For the Southeast Industrial sector, capital values are up marginally up over that period at +0.7%, while parts of the Office sector have recorded significant capital value declines, with South East and Rest of UK Offices showing falls of -12.2% and -9.2% respectively.

Offices: Vacancies continue to climb but flight to quality still evident. A strong pipeline of office delivery is coinciding with a recalibration in the need for office space as most organisations settle into hybrid working. This will continue to put downward pressure on rents, and investment levels, although the continued demand for prime stock, whether that’s redevelopment opportunities in the investment market or demand for office space in cities, will mean this part of the market will outperform. Locations where supply is more constrained will fare best.

Industrial: Slowing market.  Demand for industrial space slowed in Q2, and investment levels also fell back amid the cloudier economic outlook, but the UK vacancy rate remains low, supported by a tight pipeline. The vacancy rate is beginning to climb in London however, but rental growth continues apace in this market across the UK, albeit at a slower rate than in the last few years. This rate of growth is expected to slow, but remain firmly in positive territory, and higher rateable values and higher energy costs will also have an impact on rental growth.

Retail: Pick-up in demand. Footfall continues to rise which has spurred demand for retail space, particularly in prime areas. Future demand will not be immune to rising prices and the cloudier economic outlook, but relatively tight supply will keep vacancy rates stable. The correction in the retail market, which was underway before the pandemic, will underpin modestly rising rents from next year when the economy kicks back into gear.

Alternatives: Demand underpinning markets for hotels and residential rental. Spending on leisure services rose by 2.9% in Q1 from Q4, and despite the rising cost of living, demand for UK hotels is strong amid a rise in staycations and robust tourism in the wake of the pandemic. Residential rents continue to rise strongly, albeit less rapidly than 2022, as demand for rented accommodation continues to outpace supply in city locations across the UK. This trend is also underpinning strong demand in student accommodation,

Development: New EPC deadlines slated to come in in 2027 and 2030 are now a key focus for developers building new stock or landlords planning redevelopment or retrofitting. Change of use is also becoming more of a consideration in several sectors, as examined in more detail below.

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