CoStar 2022 UK Review: Recovery, Volatility and Radical Rethinking

Taken from an article published in CoStar on 23 December 2022, here: CoStar 2022 UK Review: Recovery, Volatility and Radical Rethinking

If ever there was a year of two halves for UK real estate, or more accurately three-eighths and five-eighths, then 2022 has been that year.

CoStar's UK investment figures clearly show the one-and-a-half quarters of calm and recovery at the beginning of the year, and the rest of the year filled with turbulence, drama and slowdown. Real estate was on course for a record year in the opening months but transactions have fallen off drastically.

The investment total is likely to come in at about £50 billion. That figure is far ahead of CoStar's figures for commercial real estate for 2020, which was £39 billion, and pretty much matches 2019, which was £51 billion. But it is below the £60 billion in 2021 and the record-busting £63 billion for 2018, as well as being down on the £60 billion Colliers is already predicting for 2023.

The change in attitudes towards doing deals is neatly summarised by Duncan Owen, the chief executive of European real estate investor Immobel Capital Partners. “The sellers want yesterday’s prices and the buyers now expect tomorrow’s prices.”

More than most years, it is easy to pinpoint when and why things went sour.

The Mipim conference in Cannes, always a litmus test of market sentiment, found the industry still celebrating the amount of activity in the first three months, while digesting the fresh news of Russia's invasion of Ukraine and realising everything had changed. Expectations that energy costs would rise, followed by interest rates and inflation as economies suffered profound shocks have played out pretty much as predicted.

In the UK, the other big event was the short-lived Liz Truss government and its "mini Budget". Rarely has one government "fiscal intervention" so dramatically hit sentiment in real estate. It sank hard on the sudden need for interest rates to rise to counter the hit to investor confidence in the country's economy and the drop in government bond prices, sterling and inflation.

Nick Ogden, a partner at agents Gerald Eve, lists the impact of Chancellor Kwarteng's address for real estate. "From the commercial property market’s perspective, 2022 was bookmarked by the ill-fated ‘mini’ budget and its aftermath. Yields across all property segments turned sharply negative, total returns began falling at an increasingly unpredictable rate and there was a radical shift in the cost of debt. The average equivalent yield across all commercial property moved out 45 basis points in a single month in October, which contributed to an astonishing minus 6.4% monthly total return. This is the most negative figure on record, greater even than any month during the global financial crisis and when compared with the position at the start of the year, illustrates just how volatile 2022 has proved to be."

Clear themes have emerged. UK real estate and business's desire to be more sustainable has created increased take-up and demand for prime assets with strong environmental, social and corporate governance credentials while other assets are facing a big headache if they are not to become "stranded" – perhaps the key word to enter real estate's dictionary in 2022.

But the industry itself has been undergoing something of a "cleaning" itself, with some root-and-branch rethinks.

The Royal Institution of Chartered Surveyors has been going through its own makeover as it works through an Independent Review aimed at improving its structure and to help it move on from a turbulent period.

The valuations industry has also worked through a series of recommendations aimed at improving transparency and trust.

The government and the real estate industry have also tried to improve the transparency of foreign ownership of real estate, which became urgent as the UK looked to clamp down on Russians' ownership after the country invaded Ukraine.

And the industry and government have been grappling with creating a better relationship between landlord and tenant, taking notes from tough lessons learned during the pandemic.

The government has also faced increasingly urgent calls from industry to get the planning system, and, crucially, the business rates system, in order, as well as to make its Levelling Up agenda more a reality than grandstanding.

Leading UK real estate stocks took a continued hit this year, particularly in the wake of the mini Budget, with the familiar story of company share prices trading at steep discounts to net asset values continuing. CoStar's UK REIT stock tracker has been a good place to follow a volatile story throughout.

It is no surprise that there has been almost no evidence of real estate investment trust flotations in 2022, with Independent Living REIT's planned listing put on ice after the mini Budget.

GCP Co-Living REIT, a new closed-ended investment company, paused its marketing of a proposed £300 million initial public offering in February "in light of the events in Ukraine". That fits in with a broader dearth of IPOs during the year in the UK across all areas. Except, that is, the progress IPSX is making with its fledgling plans for the UK's first stock exchange for trading in single real estate assets, with three UK assets now listed.

For the listed sector, the most recent quarter of financial results showed how values and prices have been hit by the changing environment, with rising interest rates cited for substantial hits to office and industrial values. The retail-focused REITs fared best on that metric, with much of the repricing earlier in the year.

The repricing also led to everyone looking at property funds with an eye on gating and fire sales. However, redemption restrictions have in almost all cases been placed on institutional investors in the UK, unlike 2020 when open-ended retail funds were almost universally gated. That said, there are many assets in these funds up for sale.

However, Blackstone's recent decision to limit redemptions has sparked similar moves from non-traded REIT peers such as Starwood and blown a cold wind across global property markets.

Dan Green, partner at Tri7, a specialist value-add real estate investor and asset manager, neatly sums up a year of volatility.

"The first six months – particularly in the ‘beds and sheds’ sectors – saw yields hitting all time lows and huge amounts of capital flood into the UK market. The second half, characterised by a merry-go-round of politicians and a worsening macro economic climate, saw larger than expected interest rate hikes and a knock-on effect on yields. And with one more Bank of England Monetary Policy Committee meeting before we wrap up 2022, to paraphrase Dorothy: Toto, we’re certainly not in cheap money territory anymore." That meeting has since taken place and lifted the rate another 0.5 percentage points to its highest level in 14 years – definitely not cheap money territory.

But there are reasons to be optimistic for 2023. As Green points out: "While the cost of living crisis and recession has subdued investor demand, the fundamentals of the beds and sheds markets remain extremely strong."

And there have been many, many memorable transactions, developments and innovations. To name a few CoStar News has covered in depth: Battersea Power Station finally opening in London; the launch at last of the Elizabeth Line, and the largest single-asset UK real estate transaction, the sale of UBS's 5 Broadgate headquarters, revealed by CoStar News.

Grounds for Optimism

Mark Allan, chief executive, Landsec, says although the industry is still faced with challenges, his REIT is entering 2023 with optimism and ambition.

He says there are three key areas where the group can drive positive progress – cities, carbon and communities.

Allan explains: “Bolstering the health and wellbeing of citizens will be essential in ensuring people feel proud of their local areas. Creating destinations of choice, which attract new families and talent, will ultimately fuel economic growth.

“We need urgent but sustainable action to drive down built environment carbon emissions. Landsec has set out its progress to date and how we are employing innovative new technologies to building a greener, fairer society that works for everyone. We now need government support to accelerate the net zero transition.

Melanie Leech, chief executive, British Property Federation, says the year will be remembered for both economic challenges and political upheaval and uncertainty.  

But she says that despite cost inflation and massive challenges facing the UK economy, there are reasons to be proud of how real estate has reacted this year.

"We should celebrate the commitment of the property sector to continue to innovate and collaborate in the race to net zero.

"Decarbonising the built environment is a massive challenge and fundamental to the UK achieving net zero by 2050. In a difficult year, sustainability has remained at the very heart of strategy for increasing numbers of actors across the property sector.”

Leech says that with the reappointment of Michael Gove, levelling up is back on the political agenda, although with limited funding. "The Levelling Up and Regeneration Bill has had its ups and downs making its way through Parliament but is a key piece of legislation that will set the framework for our sector’s operations and how we work with public sector partners across the country to deliver homes and transform towns and cities."

Leech also says the government finally listened to the BPF and others in the industry when it froze business rates and agreed to reform transitional relief in the Autumn Statement. "More fundamental reform is still needed but this was a major acknowledgement of the barrier of business rates to the revitalisation of our town centres.” 

Fascinating and different as 2022 has been on many levels for real estate, there will be many hoping 2023 will a lot duller.