The RICS global Commercial Real Estate Market Monitor (Q3 2022) is indicating that the sector is in the early stages of a downturn. That's according to around 81% of the survey's respondents in Q3 2022. It marks a significant increase from the previous quarter sample when just 11% of the survey's respondents felt that the market would turn down.
In the latest survey, which covers domestic (UK) and foreign markets, the RICS Commercial Property Monitor gives a clear indication that both domestic and foreign investors are turning their back on commercial property.
Tenant demand is a big factor in this result in the Monitor's numerical classification scheme showing tenant demand fell to a net balance of -10 per cent, down from +17 per cent in Quarter 2. Projections for prime office values turned even more negative, with the net balance falling to -21 per cent from +15 per cent last quarter.
Fall in the value of the pound
Capital values and rental projections have as a result taken a negative turn for the year ahead, a dramatic change from the previous quarter's survey which was showing positive numbers. Despite the fall in the value of the GBPound, enquiries from overseas investment prospects are now in negative territory across all main commercial property sectors.
Everything is pointing to a weakening market activity. With reduced activity comes also the prospect on people's minds of significant further interest rate rises. This is weighing heavily on the commercial market outlook over the year ahead.
Tenant demand had been recovering following Covid with five successive quarters of growth, but now, in this last quarter, most parts of the UK are seeing a downward trend for tenant demand particularly in office and retail space. Industrial space is still in demand with a positive net balance of +21%, but even here demand is down from the +61% posted in the Q4 survey last year.
Office and Retail affected most
The decline in demand for office and retail space as well as a modest decline in industrial property demand is resulting in landlords offering value added incentive packages to tempt prospective tenants.
90 per cent of the respondents to the surveys now feel that with home working and/or hybrid working bedding in, in most companies, expect businesses to start to scale back at least some of their office footprint over the next twelve months.
One-third of the survey respondents believe this reduction in demand for office space will be in the order of 5 to 10 per cent, while an equal number are predicting that trimming office footprints could be between 10 and 20%+ over the full year.
In the RICS full global version of the survey, it found that two thirds of its respondents reported observing a modest amount of repurposing of offices properties going on, with only around 10 per cent seeing a 'significant'� reshaping of the estate.
With major external economic forces affecting the commercial market and structural changes impacting the office sector in particular, RICS thinks prime office rents will remain broadly flat over the year ahead. This is a reversal of the position they were in in the previous quarter when an increase was predicted.
For the secondary non prime office market the outlook seems even more negative. For prime and secondary retail, the story is much the same, as twelve-month projections have slipped deeper into negative territory. In the industrial sector however, rent increases are likely to be modest in comparison to the period in the early stages of the pandemic.
Key insights from regions covered in this quarter's report include:
'North America: A significant shift in sentiment has been noted from the results across North America, with previously strong expectations for growth across all sectors now declining due to the more challenging economic conditions and the prospect of further tightening in monetary policy. Though demand within the occupier market remains firm this quarter, 52% of survey participants from the United States and 59% from Canada now feel the market is in the downturn phase of the property cycle.
'UK: Feedback from respondents this quarter indicate a cautious tone as a weakening outlook for the broader economy weighs on the commercial market. Furthermore, as interest rates increase, -42% of respondents highlight a deterioration in credit conditions this quarter which has dampened momentum behind investor activity.
'Asia Pacific: Results from APAC remain varied at the national level. Sentiment in real estate markets across Singapore and India continues to improve, with tenant demand rebounding in recent quarters (net balances of +55% and +53% respectively in Q2) across all three main sectors. Sentiment from China, New Zealand and Hong Kong however declined from previous quarter and respondents now see the market in a downturn phase.
'Middle East and Africa: Sentiment from MEA remains positive this quarter, with both occupier and investment demand indicators strengthening slightly at a headline level. The strongest momentum is being seen in Saudi Arabia and the UAE, possibly due to higher oil prices. Respondents across MEA also foresee solid capital value growth in most sectors over the coming twelve months at an aggregate level.
'Europe: Macro economic impacts, such as intense inflationary pressures and the prospect of a significant tightening in monetary policy have resulted in a decline in sentiment from respondents across Europe this quarter. As per the findings, investor demand growth has stalled (dropping to -3% net balance from a reading of +13% previously) and capital value expectations have turned marginally negative overall. Some national markets however are showing more upbeat results, with Croatia and Greece recording positive CPSI.'�
RICS Economist Tarrant Parsons, says:
"Deteriorating conditions across the UK economy are having an increasingly noticeable influence on the UK commercial property market, with higher interest rates, and the prospect of more to come, now clearly weighing on investor demand.
'The weaker survey feedback is particularly evident in the retail sector, as the cost-of-living crisis and falling consumer confidence takes its toll on household spending. Likewise, the office sector has also seen a renewed decline in demand, with ongoing structural changes to working patterns brought about by the pandemic further exacerbating the broader cyclical downturn in the economy.'�
Cost of living crisis
The cost of living crisis, brought on by the war in Europe, increasing energy and food prices, and spiralling inflation, have combined to bring about interest rate hikes by the BoE, with further rises still in prospect. The net result is more caution across the commercial property market.
There was a significant deterioration in credit conditions though Quarter 2, which has had a dampening affect on investor activity. All sectors are still seeing occupier demand increasing, but this is far below the levels seen at the tail end of last year and early this year.