Commercial property has had many cycles, but this time could be different
Although some intermediaries are still positive about a rebound in commercial, a recent report by JP Morgan has shown that a number of commentators are sceptical – and we may be in for a long wait before business picks up – if at all.
The UK commercial property market, like the broader economy, experiences cyclical patterns of growth and decline. Over the past 40 years, it has faced seven distinct downturns, the seventh is the one giving us a headache now.
There is still demand out there as developers look to refinance. “The impact of those 14 consecutive interest rate hikes has seen investors carrying too much debt being forced to sell in sub-optimal conditions and fairer value opportunities coming to market,” Ian Humphreys CEO of Brickflow explained.
“For every 1% base rate increase, a developer needed £10,000 in equity per £1 million borrowed. When you extrapolate that across the circa £65 billion of annual borrowing across bridging, commercial mortgages and development finance in the UK, that’s an additional £3.25 billion borrowers have to find this year in equity, to complete the same amount of property transactions as when the base rate was 0.1% - a colossal gap.”
Commercial investors are being advised to adapt their strategies, moving away from traditional recovery models and adopting a more active and selective approach.
Historically, the UK commercial property market has been closely tied to the overall economic climate, reflecting expansion and contraction phases. Three downturns in recent history stand out:
- 1990s Recession: Between 1989 and 1993, high interest rates and a slowing economy caused property values to plummet by 28%.
- Global Financial Crisis (GFC): From 2007 to 2009, property values dropped a dramatic 44% during a period of global economic turmoil.
- COVID-19 Pandemic: Property values fell by 10% between 2018 and 2020 as the pandemic disrupted business activities and reshaped property usage.
Currently values are down by 25% according to JP Morgan. This makes it the third most severe decline since 1986. However, property values seem to have stabilised from earlier this year, showing minimal fluctuations in the following months.
Is this the right time for clients to invest?
With some signs that the market may have hit its lowest point, investors are considering whether now might be an opportune time to enter the market. Historically, major declines have often led to substantial recovery periods. For example, after the 1990s recession, the market rebounded, generating a one-year return of 26%. Similarly, following the GFC, property values rose, offering a 23% return in just one year.
But some experts caution that this cycle might not follow the same trajectory as past recoveries. Unlike earlier downturns, aggressive interest rate cuts—which have historically driven growth—are less likely this time. Predictions suggest that any reduction in rates will be slower, potentially limiting the speed and scale of recovery – and there are also unusual factors at play.
Structural shifts in the market
The market landscape is evolving, with more variation across sectors and property types – and there are other issues at play – such as those that Mark Carney has pointed out.
Shifts like the rise of e-commerce and remote work have led to significant changes in the performance of different asset classes. Industrial properties, for example, have surged in value due to the growth of online retail, while traditional retail spaces have struggled.
Additionally, there is a widening gap between premium properties in prime locations and older, less desirable assets – some of these, as the ex-Bank of England boss says, could become “stranded assets”.
The commercial property silver lining
According to Matthew Norris, from Gravis Capital, despite ongoing market challenges, the falling corporate bond and gilt yields make commercial property rentals more attractive. He told FT Adviser that recent data shows valuations have “stabilised,” suggesting potential for growth as interest rates are expected to fall further. Norris highlighted the importance of properties with modern energy efficiency ratings, as new UK regulations will require properties to have a minimum EPC rating of B by 2030. Only 16 per cent of commercial property assets in the UK have the right energy efficiency rating now.
Aaron Hussein, of JPMorgan Asset Management, added that although property values have declined between 15% and 25% in the UK, US, and Europe since the recent rate hikes, they appear to have bottomed out. He noted: “As we move through 2024, we’re seeing clear signs of stabilisation and modest gains. For properties with strong fundamentals, today’s valuations potentially offer investors a once-in-a-decade opportunity.”
However, Hussein also pointed to the growing divide in the market echoing Carney’s advice. Properties without modern efficiency standards are likely to become “stranded assets” as demand for sustainable, high-quality office spaces continues to rise. These changes highlight the need for property owners to upgrade older buildings to stay competitive.
A market of two halves
As the market evolves, there is growing evidence of a “bifurcated” market based on location and asset quality. High-quality, energy-efficient properties in prime locations show stronger performance, while older, less sustainable buildings risk becoming obsolete.
