Last year in real estate and predictions for 2023

This year has left us battered by a continual wave of events that have created a perpetual feeling of uncertainty. When war broke out in the Ukraine in February, we did not expect the conflict to last until the end of the year, or the dramatic impact it has had on energy prices and inflation across the world. A tumultuous few weeks in October saw the fall of the Truss government and the appointment of Sunak. The UK economy has slowed, household incomes have been squeezed and we are now officially in recession. However, the ship has been steadied, the Bank of England has continued to make regular rate hikes to slow inflation growth and the latest Chancellor’s fiscal statement has helped the pound and gilt yields to stabilise.

The housing market, often seen as a bellwether for the UK economy, has been impacted by rising costs of borrowing. In November house prices fell 1.4%, the sharpest fall since the Covid lockdown, and excluding that, the biggest fall since the 2008 financial crash.

As a result, the market will remain significantly dampened and liquidity will be tightly constrained. However, prime assets will always find a buyer, but the secondary asset market is likely to struggle. Uncertainty will remain, making predictions difficult, but this is how I think certain real estate sectors are likely to fair in the coming year.

BTR to stay on top?

Significant investment through many years of low interest rates has led to compressed yields as increased competition saw prime sites achieve premium prices. Yet in the latter half of the year, yields began to soften slightly as yields on gilts rose, which had potential to dampen investment appetite. However, it is clear there remains an almost insatiable appetite for long term multi-family residential income streams, despite the forecast parity to longer term gilt yields. I expect yields will stabilise next year.

The student PBSA model is similarly counter cyclical in nature, with increasing student numbers driving up demand and occupancy levels. However, rising energy prices are now a factor, with energy accounting for 23% of operational costs (excluding management fees). Operators may opt to pass the energy price risk onto occupiers, in line with other European countries, however, this would only be viable if demand continues to outstrip supply.

Will the post-Covid life sciences boom continue?

Life sciences has become central to the UK’s economic growth; the government has committed to investing £22 billion in R&D by 2026/27. The economic situation could put constraints on financing R&D which would have a knock on effect on occupier demand and potential rental values but, institutional investor appetite remains strong with fierce demand in the Oxford, Cambridge, London golden triangle locations. ASK has funded two life sciences projects this year. And, a planning application has been submitted for a 23-storey life sciences campus in Canary Wharf as appetite for the sector overtakes financial services.

Retail continues to be repositioned

Retail was hard hit long before Covid finally wiped out those that were struggling. Leading retailers switched to quality not quantity of outlets, which supported growth in prime locations, and have adopted a multi-channel strategy. Growth has been almost exclusively driven by online sales but well-located stores are seeing an improvement.

There have been many opportunities to invest in this sector and ASK has funded three large retail projects this year. As this market has already seen a price correction, yields are outperforming rising interest rates. Non-performing assets have provided perfect opportunities to re-zone into mixed use schemes, and perhaps no better evidenced by the changing face of London’s previously prime Oxford Street, which currently has four former/current department stores being demolished, converted or in planning for conversion into new mixed-use schemes.

Appetite for industrial has not been dampened

The demand for warehousing has been growing for some time. Steep increases in online shopping, even before the pandemic, have driven demand for suitable sites. Likewise, the rise in online grocery and takeaway food ordering has fuelled requirements for dark kitchens and storage solutions.

However, this sector will see significant rises in business rates next year as the recent re-evaluation of rateable values, was based on the period 2015-2021. This market has changed exponentially since then and distribution and logistics properties will see an average increase in their rateable values of approximately 35% from April 2023. I don’t expect this to deter investors. Blackstone, the most active buyer in this sector has continued to ramp up acquisitions making 55% of its European holdings in this sector.

Hotels and leisure bounce back

According to a report by Knight Frank, the UK hotel market has performed well this year. Shored up by domestic leisure, new demand from flexible work arrangements, and the weak pound, the average daily rate has risen 22% compared to pre-pandemic levels which is providing a cushion to high cost inflation. Having been hit hard, hotel owners are being savvy about future growth, but if the pound remains weak, they will continue to benefit from an increase in international visitors.

Leisure facilities are becoming popular additions to our high streets, taking up vacant retail sites. Trampoline venues which have done well in the US are fast becoming a new trend here.

The office market revival

Office rental values are almost at pre-pandemic levels yet in fact there are high vacancy rates across the capital in less popular areas. This is because tenants are trading for higher quality space in the best locations to entice employees back to the office. We are now seeing effectively a two-tier market, between grade A and lower quality stock with high demand for the former. Research conducted by Savills states that based on planning applications, 1.32m sqft of retail is set to become new offices on Oxford Street in the next five years. There is significant potential for repurposing inferior stock to meet market expectations. I think this market will continue to recover as employers start to insist upon a return to the office.

Expectations for 2023

I would expect a similar two-tier situation in the property market overall next year. Prime assets will remain highly tradable, especially at the right price but with yields at the same as interest rates, the market for secondary and tertiary assets in inferior locations is more likely to flatten considerably.

Developers will be challenged by the rising cost of repurposing secondary real estate and new builds because of inflation and ESG requirements. However, I believe demand will still drive new projects, but finance costs will be materially higher.

Flexible alternative lenders will find less competition in the market as other players are forced to withdraw and there will be potential to acquire non-performing loans at a sensible discount. At ASK we expect our partnership with OakNorth Bank to help generate more opportunities and to be able to continue to originate interesting debt opportunities whilst maintaining our high underwriting standards.