Price Discovery Stalks Commercial Property Market

Aidan Gavin, Managing Director, Cushman & Wakefield, explains why sentiment surrounding commercial property changed through 2022

2022 has been a year of incredible twists and turns, with the property market ending the year on a very different footing to how it began. Interest rates in November were a full 200 basis points higher than at the start of year, with further hikes anticipated.

3 Year swap rates hovered at 2.7% in November 2022, up from -0.25% in November 2021, while inflation has remained above 8.5% since June, up from 5.3% in November 2021, or -1.1% in November 2020. In addition, the tech market in the US and globally has taken its first substantial hit since the Dot.com bubble, with many large employers admitting to having expanded too aggressively in recent years.

POST-LOCKDOWN EUPHORIA

Casting our minds back to Q1, Covid-19 restrictions ended and there was a euphoric feeling across the country. Business and consumer sentiment increased, with the commercial property market feeling the effects. In offices, the volume of space signed and reserved rose, alongside live requirements. At the end of Q1 2022, a total of 116,100 sq m was reserved in the office market. This was a return to levels not seen since pre-Covid-19 and a notable rise from just 32,700 sq m in Q4 2020. The best building in the best location was a clear trend in demand, while activity was also focused on buildings with high energy ratings and strong ESG accreditations.

As we moved through Q2, this robust level of activity continued, and the investment market recorded €1.96bn of capital inflow for the first six months of the year, sitting above the 10-year average for the period. In addition, rental growth was evident in the prime retail market, although location-specific, and logistics saw particularly strong occupation levels in new builds.

INTEREST RATES LIFT OFF

However, rising inflation, the ‘lift off’ of ECB interest rates, and growing economic headwinds saw mood within the market stall in Q3. Investment activity, despite on paper strong turnover volumes, began to stall as the era of ‘price discovery’ began to unfold. Rising debt costs brought yields into focus, leading to a mismatch in vendor and purchaser price expectation. This remains the case today. Although there is widescale acceptance that yields have moved, there is still more movement ahead.

Outside of the investment market, rising debt costs and continuing construction cost inflation also played an impact on land values. The changing external environment has brought viability and funding to the forefront of conversations. Further price changes are expected, with planning permission in place being key to any land sale.

TECH DEMAND DECLINES

From an occupier perspective, the impact is less tangible thus far. Prime rents have not declined, while the volume of office space signed in Q3 was at pre-Covid levels. However, clues to a change are reflected in reserved space and grey space available on the market. Similarly, there is no denying that tech demand, which has accounted for c.35% of take-up since 2016, has dwindled. However, demand from professional services and finance has seen a substantial increase, accounting for over 50% of the reserved space in Q3. The volume of requirements for these sectors is strong, with ESG and CBD location playing a pivotal role in demand.

ESG IS TOP OF MIND

Lastly, despite all the unknowns the property market has faced in recent times, there are some certainties for 2023. ESG will continue to be at the forefront of all conversations, influencing occupier, developer and investor decisions. Other key topics during the year will be stranded assets, obsolete stock, re-purposing assets, and areas for growth will be Med Tech, Life Science and Healthcare. The era of low interest rates is over and the movement in yields represents a price correction. The quicker we move through the price discovery process the better.