Commercial market update Q2 2023

Key headlines

Economy: Sticky inflation pushing up interest rate expectations

The UK’s economic mood music has been more upbeat so far this year than many would have anticipated in the wake of the mini-budget last year. This culminated in the IMF, traditionally circumspect about the UK’s economic outlook, confirming in late May that the country would not enter recession this year, contrary to its earlier forecasts. However, this was more a technical update rather than a clean bill of health.

Inflation has started to fall back, but not by as much as many were expecting, and food inflation is still running at 19.1%. This has raised the prospect of interest rates rising higher than previously anticipated as the Bank of England grapples to bring inflation down. In anticipation of this, gilts rates have risen sharply in the last few days, pushing up borrowing costs. Expectations are still that inflation will fall this year and next, with the Bank of England still forecasting inflation ending next year at the 2% target.

Independent forecasters are less sure that inflation will come down to that point next year, but are broadly agreed that inflation will be under 5% by the end of this year. While interest rates may peak at a higher level than previously anticipated this year, it is widely forecast that they too will start to recede in 2024.

Offices: Investment starts to build, but two tier market becomes entrenched. The number of workers commuting into the offices is rising, but the sea change in working practises is set to have a longer-term effect on demand in the market. The best quality offices are still sought-after and can command a premium, but secondary stock is slower to move, exacerbated by concerns about the cost of retrofitting to improve EPC ratings. Investment levels started to pick up in Q1 from a very quiet quarter at the end of last year, but yields continued to soften.

Industrial: Value play? After the dramatic re-pricing in the second half of 2022, there was stabilisation in yields in the first three months of the year. Tight supply mean that rents continued to rise at a clip. Rising supply as well as higher rateable values and higher energy costs will have an impact on rental growth, but it is expected to remain in positive territory, especially for high-specification units. Investment activity is picking up, with some looking for value where values may have overcorrected.

Retail: Rent stabilisation. Footfall has risen since the pandemic, but hasn’t yet reached pre-pandemic levels, which is one of the challenges for this sector. Consumer confidence has steadily improved this year, but sticky inflation data is likely to set this back somewhat. Yields in the retail sector have been factoring in the increased risks for some time, so recent movements have had less of an effect on capital values than in other sectors, and Out of Town remains more resilient. Tight supply and alternative uses mean vacancy rates will fall, creating more stable rents. Some key deals in central London are a reminder that prime retail assets are still viewed as safe-haven assets.

Development: Alternative uses. As proposed new rules on higher EPC ratings move closer, the increased cost of retro-fitting will be top of mind for landlords and developers. Where investment is being made, developers and landlords are increasingly looking at change(s) of use, alongside other asset management initiatives to increase income returns.

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