New report shows something that you should be warning clients about
Covid and the work from home boom has decimated some sectors of the property market – but it looks like there could be a light at the end of the commercial mortgage tunnel.
A new report has highlighted significant changes and challenges in the UK’s commercial property market, touching on various sectors including retail, office, and industrial spaces. And while the good news is that the UK is recovering more rapidly than the rest of Europe following a two-year downturn caused by high interest rates, significant risks still loom, particularly around underinsurance and property value fluctuations.
According to insurance broker Gallagher, 46% of commercial properties in the UK are underinsured, exposing owners to substantial financial risk – but the shortfall isn’t deliberate. The study found that inflation, driven by a 36% increase in building material costs since 2020 and a 7% rise in labour costs in the last year, is a key factor in underinsurance. Supply chain disruptions and worker shortages have also compounded the issue, making it difficult for property owners to realise what adequate coverage should be.
Phil Daly, claims director at Gallagher, emphasised the importance of working with risk management specialists, stating, "This data highlights how essential it is for property owners to collaborate with risk management specialists when securing insurance. Failing to do so leaves them exposed to substantial financial danger."
In addition to underinsurance, regular property valuations have been neglected, further contributing to the problem. The study found that 37% of claims managers attribute underinsurance to the failure of property owners to reassess the value of their properties, which should ideally be done every three years. As a result, 67% of claims managers have had to reduce or reject claims due to insufficient coverage, while 62% said the issue has worsened over the last five years. The good news, however, is that your commercial mortgage clients may have more equity in their properties than they realise.
The volatility in property values has not helped. The UK commercial real estate market has seen some recovery, with property deals increasing by 7% and €26bn worth of transactions recorded in the first half of 2024, according to MSCI. While other European markets like Germany and France lagged, the UK’s recovery was fuelled by the market perceiving there to be more political stability after the general election and stronger economic prospects.
According to Savills, returns on commercial properties averaged at 6.07% at the end of Q2, and the consultancy is bullish on improving figures for landlords. “We are seeing rising confidence in the UK’s economic fundamentals which should drive tenant demand and feed through into yield hardening from the end of the year,” James Gulliford, joint head of UK commercial investment said. “As the typical retail rental cycle is still underway, with rents now rebuilding after previously falling when they reached affordability peaks, retail rents now join prime industrial and offices in seeing consistent rental growth.”
And it looks like some mortgage intermediaries are keeping busy in the sector - “Acute shortages in UK housing supply continue to create a favourable environment for investors and developers,” Ian Humphreys CEO of Brickflow told Mortgage Introducer. “The requirement for commercial property finance remains strong. Auction activity remains strong with motivated sellers, or their lenders, seeking a quick exit, so those with the ability to transact swiftly are benefitting, and bridging finance is undoubtedly flavour of the month right now.”
However, the recovery has been uneven across sectors. Prices for warehouses, residential properties, and hotels have seen modest gains, while office properties continue to struggle. In fact, the first half of 2024 marked the lowest level of office transactions in the UK since 2001, with just €4.2bn in deals. The slow rebound in office spaces contrasts with improving demand for other property types, such as student housing and hotels.
In the retail sector, sales volumes have been erratic, influenced by unpredictable factors like weather and political events. Nonetheless, retail sales volumes rose by 0.5% in July, a marked improvement from the previous month’s decline. Non-food stores and department stores saw notable gains, with department store sales increasing by 4.0%. Retail rental values have shown some growth, although they remain 16.5% below their 2018 peak. High street rents, which had fallen almost 29% between 2018 and 2023, have started to recover, with 1.9% growth by mid-2024, primarily driven by the London market.
The industrial sector, particularly logistics, has also faced shifts in demand, which had spiked during the pandemic due to supply chain changes and the rise of e-commerce. While demand for larger distribution units has slowed, there is still strong interest in "last-mile" delivery units in urban areas. Despite overall lower demand levels, industrial rental values remain strong, with annual growth of 6.3% as of July 2024, significantly higher than general inflation.
Looking ahead, the recovery of the UK’s commercial property market appears to be a mixed picture, with some sectors bouncing back while others face ongoing challenges. Ben Sanderson, managing director of real estate at Aviva, pointed out that the recovery would likely be "k-shaped," meaning certain property types will continue to struggle while others improve. Investors are becoming increasingly selective, with US private equity firms like Blackstone focusing on high-demand sectors such as logistics, residential, and hotels.
