UK Capital Markets: economic headwinds continue in 2023 but opportunities still available
Geopolitical and economic headwinds are expected to impact global growth this year and subsequently commercial real estate (CRE) investment.
6 minutes to read
The UK will not be sheltered from these headwinds, however, the fundamentals for the UK CRE market remain.
The UK CRE market is underpinned by currency benefits, relatively attractive yields compared to core mainland European locations and its liquid, safe-haven profile.
Currency benefits
Over 2022, we have seen a depreciation of sterling due to economic uncertainty, geo-political headwinds and market views on inflation. Sterling is currently trading at $1.24, up from the record low of $1.03 it fell to in September 2022, but below the $1.37 it was trading at in January 2022 and offering currency benefits for overseas capital.
With this in mind, our Knight Frank Capital Gravity forecast expects the UK to be the top market for cross border investment within the EMEA region this year and the second most invested market globally for cross border investors, behind the US.
Globally, the UK is forecast to be the top market for office investment in 2023, the second market globally for Residential, Retail and Hotel investment and the third market globally for Industrial investment.
However, if we were to look at the EMEA region in isolation, the UK is expected to be the top market for cross border investment in all sectors except for Industrial, where the UK is second to Germany.
Overseas investment
Capital from the US, Canada, Germany, the UAE, Singapore, Sweden, and Japan amongst others are expected to drive overseas investment into the UK in 2023. US investors, who are anticipated to account for largest share of investment into the UK this year, are forecast to be the most active in the Office and Residential markets.
US Institutions, Investment Managers and Private Equity will be particularly active in these sectors.
The UK is expected to receive interest right across the investor risk spectrum this year, with Institutional investors, Investment Managers and Listed/REITs forecast to account for the largest share of cross border investment.
Private investors are also expected to be more active in 2023. During previous downturns, private buyers have tended to rotate back in to the UK market to seize real estate opportunities. We expect ultra-high-net-worth-individuals (UHNWI) from the US, Middle East, Germany, Switzerland and elsewhere to target the UK this year, with offices as their main focus.
While we are expecting demand for commercial real estate, particularly from overseas capital, we do anticipate overall volumes to moderate this year, given the global economic headwinds. In 2023, UK commercial real estate investment could moderate by c.13% year on year, as elevated inflation, higher debt costs, supply chain constraints and global geo-political headwinds impact investor appetite.
However, some markets are expected to remain buoyant in 2023. Indeed, the retail sector is expected to benefit from years of rebasing and rightsizing, with investment forecast to increase by c.10% this year, largely driven by increased demand in the Retail Warehouse sub sector.
Specialist sectors
Specialist sectors such as Data Centres, Healthcare, Life Sciences, Student Accommodation and Residential are also likely to see robust demand next year. For the UK Build to Rent (BTR) sector, a proven counter-cyclical asset class, investors will likely continue to be attracted to its low volatility and resilience of the rental market, its structural supply shortfall of rental homes, as well as its growing tenant demand and positive rental outlook. Similarly, Student Accommodation is also a counter-cyclical asset class, which will make the sector well placed for activity.
Data Centres are also likely to see strong demand in 2023, underpinned by the double-digit rate of digital transformation. The tech titans will again be particularly active, growing both global footprints and Cloud infrastructure and services. For Healthcare, the sector benefits from structural drivers such as the UK’s ageing population and a lack of fully fit for purpose bedspace, which means the sector is expected to receive renewed demand, despite wider headwinds.
For the UK Industrial and Office sectors, we are expecting investment volumes to moderate this year. However, for Industrial, this is moderation from a strong performance in 2022, and Industrial and Offices are still projected to be first and second for UK investment in 2023.
UK offices
UK offices could expect to see pressure on pricing in the first half of 2023 if the Bank of England continue to raise rates as expected. For Prime London offices, the correction for the West End will likely be less pronounced than in the City as it is supply constrained and seen as an inflation hedge, whereas the City has more debt sensitive investors active in the market.
Similarly, for the UK cities, pricing for prime offices has already shifted by 50-75bps depending on the region, and we could see further readjustment as pricing discovery continues into the early part of 2023. Furthermore, the polarisation between prime and secondary yields can be expected to widen this year, as investors seek less risky prime assets.
UK industrial sector yield compression
Similarly, the UK Industrial sector has recorded strong yield compression over the past few years, which has made it particularly exposed to elevated interest rates. Indeed, over the past six months, the sector has seen yields soften by 175bps - 200bps and if interest rates continue to rise in early 2023, yields could soften even further.
However, money markets have already priced in further rate hikes and the swift pace of repricing in 2022 should support investor activity in 2023, although the cost of debt could impact investor sentiment.
Debt cost increasing
Indeed, with interest rates and the all-in cost of debt elevated, affordability challenges are expected this year for UK investors. In 2018, c. £50 billion of debt was originated in the UK. Additionally, UK property investment in 2017 and 2018 was 30+% above the long-term average and a lot of debt was extended throughout the pandemic, which means we are expecting a sizeable amount of debt to come to maturity next year.
Assuming a five-year loan term, debt back buyers will be facing a higher cost of debt upon refinancing as these loans come to maturity. Higher debt costs may lead to opportunities for equity injection/partnering as well as assets being bought to the market for sale, should the investors choose not to refinance.
The current lending arena is different to the GFC, with a broad range of bank and non-bank lenders providing a depth of liquidity which did not exist during the GFC. While the non-bank lenders are relatively untested through more challenging conditions, there are indications of capital waiting in the wings to deploy through non-bank lending over the next year.
Across sectors, we are likely to see polarisation in performance. Increased investor demand combined with easier to secure financing of prime assets mean that the spread between prime and non-prime yields is likely to increase, with secondary assets potentially repricing to levels which become economical to be refurbished to a suitable, ESG enhanced level or repurposed.
Read more or get in contact: Victoria Ormond, head of Capital Markets research
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