As we started 2022, commercial real estate participants nervously looked forward to some form of normality returning after almost two years of Covid-19 paralysis. However, the clouds of the war in Ukraine were already forming on the horizon, with inflation and interest rate rises not far behind. As a globalised investment product, commercial property doesn’t exist in isolation and so 2022 was all about new learnings.
Land values remained subdued during the year with planning uncertainty, material cost inflation, supply-chain constraints and the cost and availability of finance all exerting a downward drag on pricing. Nervousness around a future government’s intentions hasn’t assisted either. Yet, for all of this, there remains a housing crisis and a significant part of the solution is an increase in supply of new homes. For cash-rich developers, there is now an opportunity to secure prime sites in an almost uncontested market.
On the office property occupier side, many called working from home a temporary phenomenon, which has proved to be an incorrect assessment. The impact of working from home, coupled with changing equity-investor sentiment towards the tech sector led to the offloading of surplus office accommodation from July. As a result, the true Dublin city centre vacancy rates moved from 8.6 per cent in January to 10.8 per cent by the end of September. Consequently, occupiers had a better choice of property, much of which had high-end fit-outs in place, thus saving significant capital expenditure for those relocating. Notwithstanding this, rental levels remained stable but incentives moved in favour of occupiers.
The retail market has had a difficult run and is still struggling to adapt to continuing structural changes with online transactions eroding the revenue of physical stores. Cities have been most impacted with footfall and, as a result, spending, not having recovered from Covid-19. Labour shortages also made it a challenging environment for most retailers and, naturally, inflation coupled with higher interest rates didn’t assist. Unsurprisingly, rental levels fell and investor sentiment towards retail is best described as muted. However, where landlords were willing to accept the changed rental landscape, there were deals to be done, with Grafton Street being a good example, clocking up seven different lettings.
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The industrial occupational market performed well during the year with several large requirements remaining active. In such circumstances, landlords became more bullish and leasing terms moved in favour of landlords with rents increasing, albeit there was some resistance from third-party logistics providers who are working to tight margins. Supply during the year remained tight (below 3 per cent) and while there are new buildings being completed, construction commencements is limited. Consequently, this sector remained resilient to the headwinds.
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Given the above, it’s no great shock to read that the investment market struggled to find any level of consistency with investors’ perceptions reflective of the headwinds in occupational markets. Naturally, the changing interest rate environment led to a shift in investment yields, albeit the yield changes to date don’t match the ECB interest rate. There remained high levels of conviction towards residential investment, which as an asset class represents more than a third of all investment market activity for the year. Globally, there is $413 billion of equity for investment in the real estate sector and institutional allocations to real estate is increasing (in 1980 it was 2.1 per cent, 5.6 per cent in 2010 and is estimated to be 11 per cent by the end of this year) and should act as a tailwind for investment activity. However, as we end the year, many global institutional investors are reporting an over-allocation in real estate as a result of falling equity prices distorting investment funds’ asset-class distribution. Despite this, most investors expect attractive buying propositions to emerge over the next 12 months or so.
As we move into 2023 the uncertainty witnessed during 2022 will become normalised; we will stay in a “risk-off” environment, especially if geopolitical tensions remain high. Investment pricing is likely to drift downwards for a period of time, with perhaps a change in US interest rate policy acting as an inflection point to market sentiment. For office occupiers looking for short-term fitted solutions, there will be plenty of choice but for those looking for large ESG-compliant headquarters, the choice will be limited, with little or no value to be had. As ever, the commercial property market will continue to be influenced by micro and macro factors with plenty of opportunities for those willing to make medium- to long-term calls.
James Nugent is a senior director and head of the commercial property transactional division at Lisney
