What does 2023 hold for the UK's commercial real estate market? Part 1

The last 12 months were undoubtedly challenging across all asset classes, including the commercial real estate market. Russia’s invasion of Ukraine ramped up the price of energy and other commodities, piling more pressure onto an already inflationary backdrop.

If we had to identify the low point of a difficult year, for the UK, it undoubtedly came after September’s mini-budget and for the real estate market, it was quite a shock, with a falling pound and rising gilt yields leading to markedly higher interest rates and a pensions industry in crisis.

Recession in 2023?

While the UK has so far managed to dodge a ‘technical recession’ (two consecutive quarters of negative GDP growth), things are still far from positive – further suggested by January’s International Monetary Fund report. As a result, we still think the remainder of H1, 2023 is likely to be hard going, with higher debt costs and lower investment volumes, before things start stabilising.

Until then, it’s going to remain a very challenging environment, particularly for smaller companies. Many will have grown used to operating in an era of interest rates at historic lows. That period – where borrowing felt almost free – is now at an end, and companies that have over-levered themselves, or been operating at very tight margins, are going to come under increasing pressure in 2023.

Tougher times create winners as well as losers. Institutional investors (some pension funds, private equity firms, insurance firms and sovereign wealth funds) are all still flush with cash. As these larger institutions try to find the optimal point to buy, we should see a pick-up in acquisitions later this year. The challenge is whether the cost and quantum of debt rises to the point where it stops being accretive to total returns.

What about commercial real estate property owners?

Property owners that are more highly indebted, and are struggling to ride out the current uncertainty, may be left with a fairly limited set of options. They will probably be reluctant to sell their buildings at what they see as subdued prices and debt funds are by no means “cheap”, often requiring double-digit returns for a secured position in the capital stack. Additionally, they face the challenge of environmental upgrades and may be unable – or unwilling – or lack the knowhow – to spend the sums required to achieve energy efficiency standards. In previous economic downturns, these property owners would have either had to sell or enter into a potentially complex joint venture agreement with a new partner. Either way, full control over the asset would be lost.

With IPSX, property owners can have the shares in multiple assets they own, admitted to trading on our exchange. They could raise capital by floating 0-100% of the equity of the underlying assets, thereby still retaining economic ownership to match their desires or requirements. That cash can then be used to get the building up to spec, or even used to pay down debt. In this scenario, property owners are effectively hitting two targets:

• First, they should improve their standing with their existing lender, or lenders, demonstrating they have viable access to capital for improving the building, thereby unlocking long-term value; and
• Second, they are tapping a new investor base that traditionally has no direct access commercial real estate

Furthermore, this new investor base is often trusting the incumbent manager to drive the asset forward in accordance with its business plan avoiding the change of direction that occurs when new partners are admitted to a typical joint venture.

In a challenging market environment, when the best result for many will be to merely survive the current uncertainty, this approach could really be a “silver bullet” – helping them solve any short-term financial concerns while raising capital for refurbishment to achieve their longer-term strategic aims. The commercial real estate sector might have suffered a shock to the system in 2022, but reports of its longer-term demise have been greatly exaggerated.