After the Fall: 2023 Could Be the Buying Opportunity of a Generation
Savills Unveils Its Top Picks for Returns and Its Top Themes in Annual UK Look-Ahead
By: Paul Norman
After the fastest fall in UK commercial property pricing on record in response to this year's mini Budget, 2023 is set to offer the buying opportunity of a generation for many investors.
So says Savills in its always-provocative annual look-ahead across commercial, residential and rural property markets.
It predicts retail warehouses and poor livestock land will see the highest investment returns between 2023 and 2026 of 9.8% and 8.4% respectively, in its cross-sector forecast. It argues that while poor livestock land is set to see significant growth in its capital value, retail warehouse performance will be driven by income returns over the next four years.
It says that will be the case for most UK property sub-sectors as the economy enters "a new era", where capital returns slow, and income becomes the main driver of investment performance.
James Gulliford, Savills joint head of UK investment, said in a statement: “The second half of 2022 saw the most rapid repricing of market yields that we have ever recorded, and this sets us up for a return of activity and then a period of price stability later in 2023. In some sectors, for some investors, this could be the buying opportunity of a generation. But the long post-global financial crash cycle is over, and investors will have to approach this opportunity as a new era when income will be the main driver of total returns across most major asset classes.”
Commercial Forecasts and Top Picks
In the commercial markets, despite rising interest rates and the cost of debt suppressing investment volumes and returns in late 2022 and early 2023, Savills says that continued occupier demand for prime high-quality, sustainable offices and warehouses will deliver rental growth whatever recessionary shocks lie in wait.
It forecasts that commercial prime capital values are likely to reach their nadir in early summer 2023, as the opportunistic buyers call the cycle. At that point it says investors who follow structural trends will become "comfortable that UK occupational dynamics have not materially changed".
Savills predicts logistics to have a softening in occupier demand from the peaks seen in 2020-21 thanks to the weak consumer environment in 2022. But long term, it says near-shoring and shortening supply chains will support demand for logistics and manufacturing space. It thinks a slight short-term increase to the overall warehouse vacancy rate from near record lows in 2022 is probable. But as the economy returns to growth, the undersupply of prime space will lead to rates falling and rental growth accelerating.
Retail capital values were adjusting before COVID-19, and therefore the current high yields need less correction to reflect higher base rates, Savills points out. It thinks UK retail will have a tough time in the first half of the year but vacancy rates are expected to turn downward in the second half, with some rental growth in some sub-sectors.
High street shops in suburban and commuter towns are likely to outperform, given trends towards higher footfall, and it thinks bulky goods retail warehousing is more exposed given its dependence on the sale of big-ticket items. The high income return on offer should, however, mean that this sector delivers some of the best commercial property total returns over the next five years.
Savills says lower office occupancy levels will be driven by a rise in subleasing. But given the "overwhelming lack of UK offices with high environmental ratings", and a fall in speculative development due to the tightening debt market, prime office rental growth remains "deliverable".
Top Commercial Investment Picks for 2023
Prime and green office development for delivery into 2025-26.
High street shops in affluent commuter towns and London suburbs to capitalise on agile working related shifts in consumer spending.
Prime mid-box logistics development for delivery into an undersupplied 2024-25.
Speaking to CoStar News, Mat Oakley, head of UK and European commercial research, said the rising interest rate environment was challenging but said the commercial market will carry on paying rent and making its debt payments. "So, as with the housing market and mortgage payments, you will look at what else you will you cut back on. For this reason retail warehousing will be top performing. What can people spend less money on, well it's stuff, but you will still need the essentials. Retail warehousing was weirdly resilient coming out of COVID and it has produced above-level stable income return."
For the rest of commercial property there are "one or two wrinkles", Oakley said.
"After the fast fall in commercial property yields, prices plateaued this month. I think that is the story through December, January, February and March. And then another shock will come probably post-Mipim as people reach peak uncertainty around bad news on energy price rises and inflation and interest rates. I think there will probably be a second slippage in values then."
After that, the opportunistic buyers are likely to emerge, Oakley says.
"The opportunistic money is waiting to return. The risks for me is there is always something that comes along and surprises and I think it will be around interest rates. I think we are not seeing as much forbearance in the corporate debt market as residential. Business insolvency is going up steadily quarter by quarter and businesses will struggle with rising input costs and debt and there will be a pick up in business failures."
Oakley said that will play into an increasingly two-tier market.
"Every week planned development starts are being delayed, on average by six months. While a reasonable amount is coming through next year, in 2024 and 2025 there are less than normal development completions and there is an ever-increasing bias towards prime and green. We are set to revise our prime rental growth series upwards in January because of this undersupply of prime and green in logistics and offices."
In retail, Oakley says suburban London locations look a very good pick as the idea of workers locating around commuter towns is looking increasingly persuasive. "I don't think agile working is going away and it will be a very good time to do development into this space."
But, he says, everything stems back to gross domestic product growth.
"Over the next five years there is no real GDP growth expected and real estate performance does follow this so that does not imply a dramatic turnaround because we have not gone down hard. As my colleague James Gulliford says, 'too many investors have relied on the yield-hardening fairy'. It will be about income returns going forward."
Savills' Residential Top Picks
For residential property, Savills says 2022 marked a clear turning point. For private mortgage-backed purchasers, much higher costs of debt are expected to suppress transaction levels and put downwards pressure on prices in 2023 and, to a lesser degree, the first half of 2024, it predicts.
It forecasts mainstream house prices to fall by 10% at a national level in 2023, but these losses are likely to be made up by 2026, with a limited number of repossessions or forced sales.
The less mortgage-dependent prime end of the market will see smaller price falls, with central London in particular offering a "currency play for equity-rich overseas buyers", Savills says.
While housing development activity will be squeezed by the prospect of a downturn in the market and an increasingly uncertain planning environment, Savills says the simple fundamentals of supply and demand mean there will remain plenty of space for investment and innovation across the housing sector over the next five years.
Savills thinks price falls and repossessions will be well below the levels in the early 1990s and post-2008.
Top Residential Investment Picks for 2023
For investors, purpose built student accommodation
For owner-occupiers, towns at the edge of the commute
For developers, risk-off opportunities: In an uncertain planning environment, developers and housebuilders are likely to be more selective, focusing on the lower risk opportunities which, for example, comply with a recently adopted Local Plan or where there is an existing presumption in favour of development.
In the rural markets, Savills predicts that farmland will continue to be a counter-cyclical play. It says macropolitical events have highlighted the regenerative power of food, fibre and fuel from land. And it points out that it has weak negative correlation with interest rates, and has consistently outperformed inflation across the last 30 years.
Emily Norton, head of rural research, says Savills predicts prime arable land values will increase in real terms by 2.5% per year and poor livestock land will increase by 6% per year over the next five years, reflecting increased emphasis on both food security and climate targets. Meanwhile, commercial forestry land, having seen record capital value growth in the last 20 years, will now see slower growth, having matured, but will still be supported by the demand for timber and lack of supply. Across the sector high energy prices mean that returns on investment in rural renewable energy projects could be greater and the payback period shorter for landholders.
High energy prices could mean that the returns on investment in rural renewable energy projects could be greater and the payback period shorter for landholders.