Auction buyers seek greater returns as high interest rates persist

COMMENT The latest sharp reduction in inflation was a welcome boost to the economy but is counterbalanced by the fact that interest rates look set to stay at current levels through till next summer at least, and the growth in GDP is hardly stellar. While the vast majority of buyers are using their own funds rather than borrowing, they are looking for higher returns. At the time of writing, gilt yields are 4.51% and tend to be a benchmark against which high-net-worth investors price returns from assets let on long leases to financially strong tenants. For investors seeking finance, the five-year swap rate is currently 4.08% and the 10-year swap rate is currently 3.9%. For the private property companies looking to invest now, assets yielding double-digit returns or ones with definite added-value potential are probably the most sought-after. Residential potential is the preferred option to add value. Looking forward As we head towards the year’s final round of auctions, it’s useful to look at the statistics from the previous quarter’s sales as a guide to what we might expect next. Our cPad (Commercial Property Auction Data) research reviews activity in the UK commercial real estate auction market, analysing a subset of commercial property auction sales and focusing solely on investment-grade assets and income-producing property with development potential. In the third quarter of this year, the UK commercial property auction sector saw 256 lots sold for a total of £159.4m, with a sale rate of 83%. Although the total amount sold was 29% above the long-term average – underlining the fact that the third quarter of the auction year is increasingly pivotal to sales volumes – market activity is still flat with trading opportunities few and far between. This does mean, however, that what is offered for sale is more likely to receive serious investor attention. In Q3, the average lot size rebounded from the previous quarter by almost 30% and stood at £623,000. But averages don’t reveal the whole story. There were a greater number of larger lots of more than £1m, rising to 45% by value of the entire amount realised, which is significant. The larger lot sizes were boosted by institutional sales, in particular in the office, industrial and leisure sectors. These accounted for 46% by value of the total sold. Buying opportunity Offices are set to be a very interesting opportunity in 2024 for the entrepreneurial investor, especially those attracted by prices which can be as much as 70% below build cost or, indeed, pre-Covid valuations. Assets that could potentially have high holding costs, if they become vacant or require asset management effort disproportionate to the value enhancement, if any, are finding a new generation of private buyers at these prices. During Q3, 27 industrial/trade counter assets sold for a total of £21.9m. Yields across the sector have remained firm, with the cPad average all-industrial yield currently standing at 8.33%. Their popularity stems from their quasi-retail use class, low site coverage, longer leases and household-name occupiers. Leisure investments continue to be popular, in particular licensed premises as they tend to have a large footprint in the town centre and the leases are longer than the standard shop lease and often have RPI-linked rental uplifts. However, the operator needs to demonstrate a strong trading history, or alternatively that there is a good prospect of changing use to residential, if the best prices are to be achieved. Retail subdued At 54%, the number of retail assets accounted for one of the smallest proportions of total sales achieved over the past 10 years. Stand-alone retail is still to re-establish its allure unless it has some change-of-use potential or offers a high yield with a good trading position. Retail parades, of course, remain highly sought-after for their active management potential and risk spread. The cPad average all-retail yield stands at 8.39%, having moved out by 43bp since Q2. Assets that may be over-rented, let to financially mediocre tenants or with no clear way to add value can be snapped up at double-digit yields. This is an acknowledgement by some sellers that former valuations are now irrelevant, and so they are now taking a pragmatic view on pricing. This enables trades to take place. There is still some way to go to see a wholesale correction in pricing, but this inflection point may make 2024 a good time for buyers to re-enter the market – providing finance is available. For owners of property with loans outstanding, the high borrowing costs are a major issue, unless they are prepared to put in cash to reduce the loan-to-value ratio when refinancing. One positive facet of the market is that as lenders benefit from the enhanced profitability that higher base rates bring, they are starting to reduce interest margins. This may now allow investors to make decisions about loan renewals or refinancing to unlock equity in order to take advantage of the opportunities in this lower-priced real estate environment in 2024. Richard Auterac is chairman of Acuitus