It's now been a year since the 'mini budget' of September 2022 rapidly brought the end of the Q2/ Q3 2022's improving market conditions.
Our mid-2022 valuations echoed positive market sentiment and then they tumbled, and now in Q3 – Q4 2023, the market struggles to accurately understand where to value and trade. The created gap between buyer and seller expectations being a product of different cost of borrowing opinions.
Market yields have always been checked against the all-risk yield; the spread of which is determined by factors including interest rates and supply and demand. Market stability narrows this spread and transactional evidence is created, unstable markets make the spread uncertain. Is a prime West End office today, with a reasonable lease worth 4%, 4.25%, 3.75%? In a secondary market with weaker underlying occupation, the spread is unpredictable.
The GFC, which perhaps was a two-year run, saw a very different interest rate environment. Today the cost of borrowing has increased rapidly alongside the increasing cost of construction to meet ever evolving ESG requirements. However, we learnt that recovery was quick and fuelled by pent-up demand. The restricting interest rate and inflation relationship being the throttle as to when that rebound will be.
In today's scenario, the banks haven't lent and loan to value requirements are conservative. On existing loans interest cover requirements are under pressure and the accompanying valuations are negative. A falling value further strains the loan to value ratio. The results are cash input demands, a debt funding gap, as new terms are more expensive, a renegotiation or a sale at the wrong time – or can we wait it out.
Meanwhile the funds continue to raise equity to invest in future opportunities, the anticipation of increased available stock is evident, however with some inflation stability, I think this will give the confidence on where interest rates will settle. The phrase 'rates have already been priced in' rings around the traded property market, and my feeling is that the UK will recover quicker than other European markets.
If my prediction is correct and inflation stabilises, then the market recovery should be quicker than forecast. Right now, the volume of buyers circling every sale in the West End market, suggests a pent-up demand in that market and our advice is to carefully evaluate the risk profiles when underwriting, as the right product is letting well in our markets at good rents. To me this feels like we are approaching the bottom of the market and demand will increase the competition to buy well.
With thanks to our contributor, Jonathan Martyr - Partner at Levy Real Estate and a member of the Royal Institution of Chartered Surveyors (MRICS) and an RICS Registered Valuer. With 30 years of experience in UK property, Jonathan is an active investment advisor and asset manager advising a broad spectrum of real estate investors both UK and internationally. He has particular expertise in the private client and property investment manager/ investor markets.
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