Intelligent Investment

UK Mid Year Market Outlook 2023

July 3, 2023 27 Minute Read

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Introduction

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We entered 2023 under the spectre of a moderate recession, with high inflation and rising interest rates putting downward pressure on growth. However, while the UK economy has avoided a recession, it remains under the cloud of high inflation and interest rates. As expected, the environment has been more challenging for the real estate sector due to higher debt costs which has resulted in lower investment volumes. Considering this complex backdrop, it is not surprising that each of our sectors have faced their own challenges, with some sectors performing better than others.

To assess our progress so far and prospects for the remainder of the year, we present our Mid Year Market Outlook. Here, we review our 2023 Real Estate Market Outlook and consider:

  • What we said would happen,
  • What has happened, and
  • What will happen next

Read on to explore our full analysis.

Economy

What we said would happen

  • Having peaked, inflation would slowly recede throughout 2023. This would partly reflect a continued rise in interest rates, which would be likely to peak at around 4.5%
  • The economy would suffer a modest recession in 2023, pushing unemployment up marginally and moderating wage growth

What has happened

  • Inflation has remained stubbornly high but has fallen from its October 2022 peak, with GDP growth being slightly better than anticipated and the labour market remaining tight
  • The impact of higher interest rates on mortgage costs threatens the economy and increases the chance of a recession. However, the prevalence of 2-5 year fixed rate mortgages means that the impact will be phased in, and some households will actually benefit from higher interest rates. We think that this means that the UK can narrowly avoid a recession in 2023 and see a modest recovery in 2024 as falling inflation helps to restore spending power

What will happen next

  • Sticky core inflation has led to higher-than-expected interest rates with the prospect of more hikes to come. This will cool the economy and lead to a more muted 2024 recovery than we expected six months ago
  • The labour market remains tight with low unemployment, but earnings growth is still below inflation and higher mortgage rates will impact disposable income further. This will further affect consumer demand and housing market activity


Economic

Investment

What we said would happen

  • Real estate prices would stabilise in 2023. Real estate yields would not rise to the same extent as Government bond yields and going forward, the spread over gilt yields would be tighter than in the last decade
  • Transaction volumes would be lower in 2023. Still, constraints impacting some investors mean opportunities for others, and private capital awaiting deployment could be one of the beneficiaries

What has happened

  • According to CBRE's monthly Index, capital values for commercial real estate saw little change in the first part of the year (this follows a fall of c. 20% in the latter half of 2022). Real estate yields stabilised, but Government bond yields fluctuated in 2023 so far, reflecting the uncertain outlook for inflation and interest rates
  • Transaction activity has fallen significantly. We estimate that £8.1bn of investment property transacted in Q1 2023, down from £10.3bn in Q4 2022, and far below the £21bn that transacted in Q1 2022


UK quarterly investment transaction volumes (£bn)

Source: CBRE Research

What will happen next

  • We do expect a gradual recovery in transaction activity in the second half of the year. While some investors might maintain a wait and see position, other investors will come under pressure to either release or deploy capital as the year progresses
  • Any recovery in either market activity or capital values is likely to be uneven, with investors exhibiting more appetite at present for residential, logistics and operational assets, but we are likely to see divergence in the fortunes of prime versus secondary quality assets across all sectors


Investment

Sustainability

What we said would happen

  • Elevated energy prices would continue throughout 2023. Despite six months of energy bill support from the Government, high prices would create strong incentives to improve energy efficiency. Onsite renewable energy sources may become more attractive
  • More mandatory disclosure requirements would be introduced in the UK. They aim to prevent greenwashing and direct investment towards more sustainable practices. New requirements would include mandatory net zero transition plans

What has happened

  • Since December 2022 wholesale energy prices have fallen sharply. But this is only now starting to feed through to consumer prices. High prices likely contributed to a greater focus on energy efficiency, indicated by the increased issuance of non-domestic energy performance certificates (EPCs) of B or better. The Government energy bill support for businesses was extended in April, but at a reduced level, until March 2024
  • UK asset managers and asset owners with more than £5bn in assets under management are required to make TCFD disclosures at both the entity and product level. These disclosures should explain how organisations consider the climate risks and opportunities related to the real estate they manage


Number of non-domestic EPCs (B or above) issued

Source: Department of Levelling Up, Housing and Communities

What will happen next

  • Mandatory biodiversity net gain regulation for development is set to come into force across England and Wales in November 2023. Developers will need to prepare for this new requirement and understand the cost implications. Read CBRE’s guide to these regulations for more information
  • Increasing sustainability data in the valuation process will allow better interrogation of the costs and benefits of green building features. Particularly, there will be more insight into how such features can protect assets from value depreciation. Existing best practice for valuing green features will be developed further


Sustainability

Office

What we said would happen

  • We expected leasing volumes to be down year-on-year in 2023, with demand upheld for the best space but poorer located, poorer quality stock becoming more difficult to let
  • Outward yield movement was expected to continue with pricing expected to stabilise in H2 2023

What has happened

  • The proportion of deals transacting above market prime is increasing, while secondary offices are slower to transact
  • Yields have moved out and total investment volumes have been constrained in the year-to-date, despite the transaction of some larger lot-size deals

What will happen next

  • Demand will increase as businesses grow in confidence and continue to form occupancy strategies. Take-up will still remain below 2022 levels, but will continue to reflect amenity, flexibility and sustainability
  • We expect a greater investment volume in the second half of the year, but the year-end total is likely to remain subdued relative to 2022 expectations due to the cost of borrowing


Office

Industrial & Logistics

What we said would happen

  • Occupier demand for logistics space would continue, albeit below recent record-breaking periods. Third-party logistics would dominate take-up as companies seek to outsource their supply chain processes
  • Following a period of significant repricing, prime logistics yield movement would slow down in early 2023 before stabilising towards the end of the year

What has happened

  • Take-up in Q1 was down 18% YoY as occupiers became more cautious and decision making slowed down. The vacancy rate increased to 2.71% in Q1, up from 2.00% in Q4 2022, driven by an increase in secondhand availability and speculative completions. Although up QoQ, the vacancy rate remains significantly below the long-term average due to supply being exhausted during the covid-boosted demand period
  • With positive fundamentals evident in the occupational market and a reduced risk of recession, we expect to see an increase in investment activity after summer. There is still substantial capital targeting the sector with smaller lot sizes particularly in demand


UK logistics vacancy rate

Source: CBRE Research

What will happen next

  • Occupational market fundamentals will remain robust, with demand continuing to be derived from a wide range of occupiers and particularly from third-party logistics. We expect that take-up levels will stabilise slightly above pre-pandemic levels, sitting above the long-term average. Some regions will experience a growth in the vacancy rate as supply of new speculative space reaches completion. However, occupiers’ appetite for grade A facilities should contribute to relatively quick absorption
  • With positive fundamentals evident in the occupational market and a reduced risk of recession, we expect to see an increase in investment activity after summer. There is still substantial capital targeting the sector with smaller lot sizes particularly in demand


Industrial & Logistics

Retail

What we said would happen

  • Consumer confidence had fallen to near record lows, and as such UK retail sales were expected to decrease in the year ahead. However, there would be less business casualties than during the pandemic and modest expansion was anticipated for well positioned occupiers
  • Given yields were comparatively higher than other sectors, retail would be better protected against the increasing cost of debt and yield movements would be less significant. Moreover, attractive pricing would maintain investor interest in the sector

What has happened

  • Consumer confidence has steadily improved since the beginning of the year. While Springboard’s all-retail average footfall has remained relatively stable at 12% below 2019 levels, sales surprised on the upside, with the ONS reporting volumes remaining somewhere between 1–2% below 2019 levels. For both metrics we note a polarisation of performance, with larger regional and smaller convenience schemes demonstrating the most resilience
  • Though the performance of certain occupiers has been hit by the wider economic headwinds, as anticipated the number of administrations has not been to the same level seen during the pandemic and so vacancy rates have remained stable. Following the modest outward movement seen in Q4 2022, yields have remained stable for high streets and shopping centres. Meanwhile, retail park yields have already begun to compress, reflecting investor interest in the sub-sector


UK Retail sales chained volume index (seasonally adjusted)

Source: CBRE Research

What will happen next

  • By the end of 2023, lower inflation will have fed through to household bills, meaning real incomes will have started to gradually recover. Improvements to consumer purchasing power are expected to translate to a pickup in retail sales
  • Well positioned occupiers are expected to continue to seek expansion opportunities in the right locations, with competitive tension and rental growth delivered in prime assets. However, more administrations are also likely. We anticipate interest rates will reach their peak in late 2023, and a clearer macroeconomic environment will translate to improved investor confidence in the market


Retail

Residential

What we said would happen

  • Prices would fall moderately in 2023, but stricter mortgage regulations (since 2014) would insulate the housing market against large scale distressed sales and, as such, a significant fall in prices. Rental growth would continue to be strong in 2023, driven by an acute supply and demand imbalance
  • Investment appetite for Build-to-Rent (BTR) and Co-Living would remain strong. However, pricing would adjust to reflect the higher interest rate environment. The challenging sales market would present opportunities for single family BTR investors

What has happened

  • House prices have decreased by 1.4% across the UK, and by 0.4% in London since the end of 2022, according to the ONS. UK rents have increased by 2.1% since the end of 2022, and by 2.2% in London. Annual growth figures are at their highest ever levels since the ONS index started in 2006
  • BTR investment totalled £1.9bn in H1 2023, 21% below than the same period last year. The Single-Family Housing (SFH) sector saw record volumes of investment of £460m in H1 2023. Yields across the sector have trended stable

What will happen next

  • The number of new sales instructions recorded by the RICS monthly residential survey has been gradually increasing. While this will help support transactions, the comparative shortfall in buyer enquiries points to further house price falls. We forecast prices to fall in the region of 6% in 2023
  • The rental market will continue to see demand significantly outstrip supply. Increasing mortgage costs for potential first-time buyers who are currently renting, a strong labour market and high inflation will fuel rental demand. We forecast that rental values would increase by 4.7% across the UK in 2023


UK house prices

Source: CBRE Research, ONS



Residential

Student Accommodation

What we said would happen

  • The development of Purpose-Built Student Accommodation (PBSA) would continue to slow due to barriers such as rising construction costs, and difficult planning conditions. Rising operational costs (inflation) would continue to hinder the development of new PBSA schemes
  • Demand for PBSA would continue to significantly outpace supply with severe shortages in certain locations. Occupational demand would reach unprecedented levels, which would translate into strong rental growth across the sector

What has happened

  • Strong rental growth has been observed, driven by supply and demand dynamics. Rental growth has also been driven by increases in operating costs, which have been predominantly driven by fluctuations in utility prices
  • Investment activity in 2023 has so far been subdued due to a mismatch between investor and vendor aspirations. Although investor demand remains strong, there is a lack of good quality opportunities being brought to market. Given the unexpected rise in inflation in February, wider global banking volatility and further rise in the UK base rate, there has been hesitation in investment

What will happen next

  • PBSA markets are expected to continue seeing a supply and demand imbalance while the student population continues to grow. Housing pressures will become more acute as PBSA development does not keep pace with demand
  • We expect rental tension to continue with schemes selling out much earlier than in previous cycles further driving rental performance


Student Accommodation

Affordable Housing

What we said would happen

  • Housing associations were resilient, so the sector would remain robust as an asset class. Arguably, the need for affordable housing (AH) would increase as it tends to during an economic downturn
  • There would be an increase in mergers between Not-For-Profit Registered Providers (RPs). There have been many mergers over the last few years, and this was predicted to continue throughout 2023

What has happened

  • Despite continued demand for affordable housing, there are currently considerable challenges to viability and delivery because of market volatility, inflation and the ongoing requirements regarding decarbonisation and building/fire safety. It has therefore been a relatively quiet start to the year with fewer transactions taking place than originally envisaged. Stock rationalisation continues to remain active
  • Mergers remain popular; the recent proposed merger between Sovereign and Network Homes will create a new 82,000 home provider. Silva Homes recently announced that they are in merger talks with Abri, which would create a 45,000 home provider. In February, the 11,000 home Swan, which was non-compliant with the English regulator, officially become a subsidiary of 105,000 home provider Sanctuary. In April, Peabody and Catalyst completed the final stage of their merger, creating one of the country’s largest housing associations with over 104,000 homes

What will happen next

  • Price volatility, inflation and contractor insolvencies will continue to impact the sector’s ability to deliver new build housing stock. The rent cap means rental income cannot keep pace with price rises, and so many providers will need to focus on maintaining existing stock rather than developing. Stock rationalisation will therefore continue to be an active sector of the market
  • Constraints on providers’ ability to develop, coupled with the increased cost of finance and balance sheet pressures, mean that traditional providers will increasingly seek alternative funding sources including partnering with private capital, to de-risk their development pipelines and meet delivery targets


010-affordable

Hotels 

What we said would happen

  • Hotel demand would continue to grow, albeit at a slower rate, with high spending leisure replaced by volume based corporate and Meetings, Incentives, Conferences, and Exhibitions (MICE) sectors
  • Despite the various economic and financial headwinds, we expected the pricing gap between buyers and sellers to close, resulting in increased deal flow in the second half of 2023

What has happened

  • While there is strong interest from both buyers and sellers to transact, there is still a pricing gap, and consequently transaction volumes continue to be subdued
  • The economic and operational headwinds are continuing to impact the operational performance of hotels. On a positive note, strong average daily rates and continued occupancy recovery are enabling hotels to offset some inflationary costs impacting GOP

What will happen next

  • We expect occupancy to continue to grow, albeit at a much slower rate, with volume being provided by increasing corporate activity. As occupancy grows, we expect average rooms rates to drop marginally
  • The pressure on household income may result in a reduction in leisure spend, but this will likely be offset by corporate and group demand


Hotels

Healthcare

What we said would happen

  • Healthcare investment activity was expected to remain robust in 2023, with investors attracted to strong occupier demand, long lease terms, index-linked reviews and the ability to deliver on ESG strategies
  • The current lending environment would create opportunities for property investors that can work with operating businesses to create flexible, long term funding partnerships. We expected this to be an area of increased activity in 2023, particularly where refinancing has become more challenging

What has happened

  • Care homes are seeing strong occupancy levels, but also an inflationary hedge as cost rises have been absorbed by customers, protecting margins and enabling providers to continue investing in staff pay, training and the assets
  • Investor and consumer demand has remained strong for retirement living, particularly for the emerging rental product. However, constrained supply and the lack of mature operators means there have been limited investment opportunities

What will happen next

  • We expect to see upward pressure on primary care rents, which will enable and encourage third party developers to meet increasing demand and deliver on NHS ESG strategies
  • There are several retirement living platforms currently seeking funding partners and are marketing a ground-breaking long-income opportunity in this space. This will provide proof of concept and pricing for retirement living over the next six months


Healthcare

Leisure

What we said would happen

  • Cost inflation and pressure on consumer spending would squeeze operators, some would take additional debt, or equity, to bridge gaps in their balance sheet
  • Operational, debt and macroeconomic pressures would see operators look to sale and leasebacks, or ground rent transactions to raise capital without losing sites

What has happened

  • Quality assets, in a good location with secure, sustainable income are holding up value and liquidity
  • Sales are more subdued due to lack of stock as landlords look to hold, collect the income and manage whilst there is a disparity between book values and market values

What will happen next

  • Recovery across the leisure sector will occur later in H2 as profitability is forecast to improve and yields stabilise as buyers see the value within the sector
  • Corporate activity is expected to improve when debt markets stabilise
  • More assets will come to market as buyer and sellers’ price delta closes


Leisure

Data Centres

What we said would happen

  • Despite weaker macroeconomic conditions, demand for data centre space would remain near all-time highs as the largest cloud service providers look to expand their presence in London
  • Data centre providers were likelier to cancel newer ventures, such as edge data centres, or plans to expand into smaller locales where returns were less certain

What has happened

  • It’s been a slow start to the year for London’s data centre market, Europe’s largest by far. For example, there were 17MW of take-up in Q1 and no new supply was delivered
  • CBRE has seen continued strong interest in London from hyperscalers this year. The world’s largest technology companies want to expand their presence in the market to ensure demand for their services can be met in future

What will happen next

  • Data centre providers are set to deliver an estimated 98MW this year, the second-highest amount of supply added in any given year
  • By the end of 2023, we expect the London market will have surpassed the 1GW mark in terms of operational capacity


Data Centres

Life Sciences

What we said would happen

  • The supply and demand imbalance of available lab space would likely to continue into 2023, particularly in the Golden Triangle of Cambridge, London and Oxford. Consequently, Laboratory rents were therefore expected to continue to increase in these locations
  • The Government had ambitions to make the UK a “Science Superpower” by 2030 and the sector would benefit from continued Government R&D funding as part of a package to deliver this

What has happened

  • Rents have continued to rise due to the ongoing supply and demand imbalance, as occupiers’ options for lab space is extremely limited
  • There has been a number of overseas biotech companies opening research and development facilities in the UK, drawn by the strength of UK science, particularly in advanced therapies. The Moderna Innovation and Technology Centre (MITC) is set to be constructed at the Harwell campus in Oxford. BioNTech has outlined its investment plans in the UK, intending to establish a research and development (R&D) hub in Cambridge and a regional HQ in London

What will happen next

  • Rental prices are anticipated to continue to rise over the next 12 months, due to limited stock availability in the market. Approximately 1m sq ft of new lab space is expected to be introduced by the end of 2023; however, this will not meet the current demand
  • To capitalise on the potential of the life sciences sector, the UK Government need to address industry concerns around the increasing costs of doing business in the UK vs other countries. In addition, they need to continue to streamline the regulatory landscape and make UK more attractive for large scale, pivotal clinical trials


Life Sciences

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