Gloom descends on UK property market amid higher interest rates, recession fears

THE UK’s commercial property scene is facing the prospect of some gloomy times ahead, with market players concerned not only about the cyclical downturn of the economy, but structural changes as well – notably, the rise of working from home.

New British Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng are looking to counter some of this pessimism and concerns of a recession with tax cuts and Keynesian borrowing.

Several property participants, however, fear that these policies will cause a further devaluation of the British pound and cause inflation to spike further, which could lead to the Bank of England raising interest rates again in the coming months.

Two indicators illustrate this move towards caution in the real estate market.

In a recent survey by the Royal Institute of Chartered Surveyors, over 50 per cent of respondents believed that offices, shops and warehouses were in the early stages of downturn. This compared with an earlier survey in April, when less than a quarter of surveyors and property agents were bearish. The majority of respondents have experienced a deterioration of credit conditions.

The other indicator is the performance of the UK’s top property companies. Since the start of the year, Hammerson’s shares have slumped by 50 per cent, British Land by 31 per cent and Land Securities by 29 per cent. Warehouses have outperformed the retail sector and offices.

Nick Montgomery, the head of UK real estate investment at Schroders, forecasts that commercial property capital values could fall by 10-20 per cent between end-2021 and end-2023. Most of the decline will be due to an increase in average property yields in response to interest rate hikes, he said. Net property yields have already risen to 4-5 per cent, compared with around 3 per cent last year.

While it is possible that some segments such as warehouses will experience an acceleration in rental growth, Schroders expects that average values will be flat.

“It’s unlikely that any part of the market will completely escape the downturn,” said Montgomery. “We expect that total returns would then settle at 6-8 per cent per annum from 2024 to 2026, assuming real estate yields find a new equilibrium level and rental growth resumes as the economy gains momentum.”

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The only glimmers of light are reflected in the history of solid long-term performance of property and continual purchases because of fears about bond and stock market volatility.

In the long term, agents say that both commercial and residential property have proved to be a hedge against inflation. Despite the impact of Brexit, London and other UK cities such as Birmingham, Manchester, Edinburgh and Leeds are seen as attractive for both domestic and foreign investors.

Cushman & Wakefield calculated that a single US dollar invested into a diversified UK property portfolio back in 1981 was worth US$62.70 by the end of 2021. During that same period, the UK’s consumer price index increased by a factor of 3.2. This implies that investors ended up with about US$19.50 in real terms after 40 years. “Put simply, UK property investment has handily beaten inflation over the long run,” said Cushman & Wakefield in a report.

Investment in UK commercial property, including industrial, retail, office, hotels and student accommodation, jumped from £40 billion (S$63.1 billion) to £60 billion last year, said property data and analysis company CoStar. This is the highest level since 2017 when investment reached £62 billion.