Ratings of the UK’s commercial property market are falling at the fastest pace since the Brexit vote and deal-making stalled, in early indications that higher interest rates could push the market into a prolonged recession.
According to index provider MSCI, UK commercial property values fell 2.6 per cent last month, the biggest monthly drop since July 2016.
“It’s a rather bleak outlook. There is clearly a significant degree of uncertainty in the market at the moment,” said Tom Leahy, head of real asset research for Europe, Middle East and Asia at MSCI.
The outlook is similar across much of Europe as investors retreated after striking deals at the start of the year. In the first nine months of 2022, 229 billion euros of transactions were completed. But in the past three months, levels are down 16 percent from the same period last year, according to real estate firm CBRE.
Rising prices and heightened risks in the economy are rapidly changing the outlook for European property owners.
Borrowing costs – a function of central bank rates and lenders’ perception of risk for the sector – have increased sharply in the past six months, while inflation has driven up construction costs.
The attractiveness of ownership has also diminished as bond yields have risen. If they remain high, commercial property yields – which move inversely with prices – will have to increase dramatically to entice investors back.
“Why would anyone bother buying commercial real estate if Treasuries stay above 5 per cent?” said the head of real estate at a large bank. Real estate yields fell 3 percent in some sectors.
Leahy predicted that eliminating nearly 15 years of ultra-low rates would lead to lower prices in commercial property across Europe.
He warned that the UK could be particularly vulnerable to deflation as a result of the recent political turmoil. As the leadership contest begins in the wake of Liz Truss’ resignation this week as prime minister, the country is preparing for its fifth Conservative prime minister since 2016.
“The idea of the UK as a safe haven is under heavy pressure because of our politics,” said Leahy, adding that political stability has been “in our interest for a long time – London was popular during the financial crisis for this – but there is a feeling that the ship is drifting away a bit at the moment.”
Real estate brokers and investors said the UK commercial property market peaked at the start of the year.
According to CBRE, investment volumes have fallen for three consecutive quarters. The number of pending transactions tracked by MSCI is at its lowest level since 2013, indicating that the market is likely to slow further.
Deals were cut at a huge discount to levels that residents considered realistic at the beginning of the year – before the war in Ukraine and rising inflation led to successive rounds of price hikes.
The biggest deal struck in recent months was Landsec’s sale of Deutsche Bank’s new London office, 21 Moorfields.
Late last year, Landsec was approached privately by a potential investor willing to pay around £1 billion, according to people familiar with the bid.
Instead, Landsec opted to go public and settled last month at nearly 20 percent less, agreeing to a £809 million Dealing with Australian developer Lendlease.
Analysts and investors said its origin Owners in northern Europe, particularly Germany and the Nordic countries, have also experienced a downturn.