Interest rate rises hit investor demand for real estate

Investors are losing interest in UK commercial real estate on the back of declining occupier demand and the impact of rising interest rates, according to the latest RICS UK commercial property monitor. Figures for Q4 2022 show that 83% of surveyors believe the market is in the downturn phase of the cycle, compared with 81% in Q3. Nearly half (49%) still consider this downturn to be in its early stages. The latest results from the survey, which measures reports of increasing occupier demand versus reports of decreasing demand to create a net balance figure, showed downward trends in demand for offices and retail. Overall demand for space from tenants fell to a -20% net balance during the quarter, compared with -10% in Q3. RICS said it marked the weakest performance since the end of 2020. Occupier demand for office space worsened to a net balance of -29%, with retail demand standing at -45%. However, demand remained marginally positive for the industrial sector, at +6%. Expectations were “modestly positive” for prime office and industrial space, said RICS.  For prime offices, a net balance of +10% predicts an increase in rents for the year ahead. Regional differences were at play, however, with London posting a net balance of +19 and the North at +13%.   While the rental outlook appears more resilient in some market segments for the 12 months ahead, researchers said the recent increase in interest rates was having a widespread negative impact on investor sentiment.   Investor enquiries fell to a net balance of -30% in the final quarter. The decline was seen across all sectors for the first time since the early stages of the pandemic. Overseas investment demand was down in every sector, compared with the previous quarter. Interest rate rises also had a significant impact on capital values, with near-term expectations falling sharply across all sectors. RICS said capital value projections for the next 12 months were now in negative territory across all three mainstream sectors, in both prime and secondary markets. All parts of the UK now display negative all-property average capital value expectations for the year to come. Credit conditions were reported to have worsened by a net balance of -73% of contributors, down from -68% in Q3. RICS said this was the lowest level recorded by the monitor since its inception in 2014. Higher interest rates were singled out by many surveyors as “ushering in a period of adjustment in market valuations”. Tarrant Parsons, senior economist at RICS, said: “The investment side of the UK commercial real estate market has been significantly affected by tighter monetary policy, with higher borrowing costs weighing on investor demand and prompting an adjustment in valuation levels.  “Indeed, linked to the rise in government bond yields over the past six months, capital values have pulled back noticeably of late, while expectations point to this downward trend continuing over the near term. That said, for now at least, pockets of resilience are visible on the occupier side of the market, with tenant demand still edging higher across the industrial sector, while the outlook for prime office rents also remains in positive territory (perhaps supported by more sustainable features). Going forward, the broader economic landscape will be crucial in determining how trends across the occupier market unfold from here.” To send feedback, e-mail pui-guan.man@eg.co.uk or tweet @PuiGuanM or @EGPropertyNews